Macroeconomic data do not show a strong correlationbetween investment and interest rates. Let’s examine why this might be so. Use
our model in which the interest rate adjusts to equilibrate the supply of
loanable funds (which is upward sloping) and the demand for loanable funds
(which is downward sloping).
a. Suppose the demand for loanable funds was stable butthe supply fluctuated from year to year. What might cause these fluctuations in
supply? In this case, what correlation between investment and interest rates
would you find?
b. Suppose the supply of loanable funds was stable butthe demand fluctuated from year to year. What might cause these fluctuations in
demand? In this case, what correlation between investment and interest rates
would you find now?
c. Suppose that both supply and demand in this marketfluctuated over time. If you were to construct a scatterplot of investment and
the interest rate, what would you find?
d. Which of the above three cases seems most empiricallyrealistic to you?