Introduction to Finance

Small Business Practice
*Jeff ry Timmons, 
New Venture Creation
, 4th Edition (Boston: Irwin/McGraw-Hill, 1994). Also see Jeff ry A. Timmons and Stephen Spineilli, 
New Venture 
Creation
, 8
th
Edition (New York: McGraw-Hill/Irwin, 2009), Chapter 18.

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8.1 Supply and Demand for Loanable Funds
195
in Chapter 5. Net additions to the money supply are a source of loanable funds; during peri-
ods when the money supply contracts, the fl ow of loanable funds can drop below the level of 
current savings.
In Chapter 4, we discussed the basic monetary policy instruments available to the Federal 
Reserve that allow it to increase or decrease the money supply and, thus, the availability of 
loanable funds. The primary way the Fed increases the money supply and loanable funds is 
through its open-market purchases of government securities. The Fed’s recent quantitative 
easing initiatives are examples of its eff orts to increase the money supply and loanable funds.
Factors Aff ecting the Supply of and Demand for Loanable Funds 
Many factors can aff ect the supply of and demand for loanable funds. Following are several 
important factors.
Volume of Savings 
The major factor that determines the volume of savings, corporate 
as well as individual, is the level of national income. When income is high, savings are high; 
when it is low, savings are low. The pattern of income taxes—both the level of the tax and the 
tax rates in various income brackets—also infl uences savings volume. Furthermore, the tax 
treatment of savings itself infl uences the amount of income saved. For example, the tax defer-
ral on (or postponement of) savings placed in individual retirement accounts (IRAs), increases 
the volume of savings.
The age of the population has an important eff ect on the volume of savings. As we 
discussed in Chapter 7, little saving is done during the formative and education-building 
stage or during the family creating stage. Therefore, an economy with a large share of young 
couples with children will have less total savings than one with more people in the older, 
wealth-building stage.
The volume of savings also depends on the factors that aff ect indirect savings. The more 
eff ectively the life insurance industry promotes the sale of whole life and endowment insur-
ance policies, the larger the volume of savings. The higher the demand for private pension 
funds, which accumulate contributions during working years to make payments on retirement, 
the larger the volume of savings. The eff ect of interest rates on such savings is often just the 
opposite of the normal eff ect of price on supply. As interest rates decrease, more money must 
be paid for insurance for the same amount of coverage, because a smaller amount of interest 
will be earned from the reinvestment of premiums and earnings. Inversely, as interest rates 
rise, less money needs to be put into reserves to get the same objectives. The same is true of 
the amount of money that must be put into annuities and pension funds.
When savings result from the use of consumer credit, the eff ect of interest rates is delayed. 
For example, assume a car is bought with a three-year loan. Savings, in the form of repaying 
the loan, must go on for three years regardless of changes in interest rates. There may even be 
an opposite eff ect in the case of a mortgage because, if interest rates drop substantially, the 
loan can be refi nanced. At the lower interest rate the same dollar payments provide a larger 
amount for repayment of principal; that is, for saving.