Financial Markets & Institutions (Supply & Demand)

Practice scenarios

Household wealth surges after a long stock market rally. What happens to interest rates, and why?

Rates fall. Wealthier households save and lend more, so there is more money chasing borrowers.

A financial crisis makes corporate bonds look much riskier. What happens to interest rates?

Rates rise. Savers pull back from lending, and borrowers must offer higher rates to attract funds.

Households face large upcoming expenses like tuition, medical bills, and a wave of home purchases. What happens to interest rates?

Rates rise. Savers hold onto cash instead of lending it, which shrinks the pool of loanable funds.

The central bank increases the money supply. What happens to interest rates?

Rates fall. More funds are available to lend, so the price of borrowing drops.

The economy is booming and incomes are growing. What does this do to the supply of funds, and the rate on its own?

More income means more saving, so supply increases and rates fall.

A new technology makes factory equipment far more profitable. What happens to interest rates?

Rates rise. Firms expect more benefit from what they can buy, so they borrow more and compete for funds.

Consumer and business confidence jumps during an economic expansion. What happens to the demand for funds and interest rates?

Demand rises as firms expand and households take on mortgages and loans, pushing rates up.

A recession hits: incomes fall, firms cut investment, and the central bank cuts the money supply less than expected. Which way do rates likely move?

Probably down. Weak economic conditions reduce demand for funds, and a recession-driven drop in borrowing usually outweighs the supply side.

You’re a corporate treasurer planning to issue bonds. Rates look low now, but the central bank is signaling it will stop expanding the money supply. What should you consider?

Less monetary expansion means less supply of funds, so rates may rise. Issuing sooner could lock in a lower cost of borrowing.

Why might a booming economy not push interest rates as high as you’d expect?

Because strong conditions raise both demand (more borrowing) and supply (more saving), partly offsetting each other.