In the simplest versions of such models financial

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Unformatted text preview: abstracts from financial frictions. In the simplest versions of such models, financial conditions can be summarized by a single interest rate, the equilibrium value of which is determined in a market for credit. Figure 2A shows the key equilibrium condition. The loan supply schedule LS shows the amount of lending L that ultimate savers are willing to finance (by refraining from expenditure themselves) for each possible value of the interest rate i received by savers, while the loan demand schedule LD shows the demand for such funds for each possible value of the interest rate that must be paid by borrowers. Note that the slopes for the curves LS and LD both reflect the same principle, which is that a higher interest rate gives both savers and borrowers a reason to defer current spending to a greater extent. Equilibrium in the credit market then determines both a market-clearing interest rate and an equilibrium volume of lending, as shown by i1 and L1 in the figure. In In Figure 2A, the loan supply and demand curves are specified while holding constant a great many variables ot...
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