Introduction

Determinations of interest rates are to explore the most important ideas about
what determines the level of interest rates and asset prices in the financial market.
Loanable funds theory recommends that the market interest rate is determined by the
effect on the supply of and demand for loanable funds. Supply of loanable funds is all
sources of funds available to invest in financial claims, whereas demand for loanable
funds is all users of funds raised from issuing financial claims. Furthermore, equilibrium
interest rate is temporary that is any forces shifts supply and demand will tend to change
D A =S A

interest rate such as

loanable funds and

SA

. Where

DA

equal to the aggregate demand for

equal to the aggregate supply for loanable funds. There is a

negative relationship between the quantity of loanable funds and interest rate in demand
function for loanable funds. However, there is a positive relationship between the
quantity of loanable funds and interest rate in supply function for loanable funds.
Economics forces that affect interest rates are included economic growth and
inflation. Impacts of Economic growth on interest rates have slowdown or increases in
growth. When slowdown in growth occurs, demand schedule will shift to the left means
that demand decreases and supply schedule may shift but little only. However, increase in
growth means interest rates tends to rise due to increase in the demand schedule. Thus,
economic growth means that shift the demand schedule to the right but there do not have
any impact on the supply schedule. Besides, impact of inflation on interest rates is it is
unexpected inflation that benefits borrowers at expenditure of lenders. Shifts the supply
schedule to the left discussed that households consumption today increase if inflation is
expected to increase. Shifts the demand schedule to the right explained that households
borrow more to purchase the products before expected inflation rise. When real or
expected inflation rate increases, interest rate also increases. Expected inflation is
embodied in nominal interest rates that is fisher effect. Fisher effect is the nominal
interest payments pay off borrowers to reduce the purchasing power and a premium for
forgoing current consumption. Moreover, fisher effect is the relationship between interest
rates and inflation and it included the expected inflation to current interest rate. Real

interest rate is the difference between the nominal interest rate and the expected inflation
rate. Thus, the exact Fisher equation is: i =r +

Pe

. Where i equal to the observed

nominal rate of interest; r equal to the real rate of interest and

Pe

equal to the

expected annual rate of inflation.

The reason of choosing the topic because interest rates are a major reason of the income
you can earn by lending money and of the aggregate you have to pay for borrowing
money. It is important that we must understand how interest rates will change; this is
because it is depends on the relative strength of its effect on supply and demand factors
and it is also affected by inflation and monetary policy. Besides, we also can understand
clearly how its characteristics determine what kind of interest rates you can invest, when
you are deciding to invest in a debt security.
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