Critically Explain The Loan Able Fund Theory Of Interest.

Loan able fund theory of interest: It is also known as the neo-classical theory of interest and developed by Robertson, Pigou, Myrdal, Ohlin etc. According to this theory, interest is determined by the equilibrium of demand for and supply of loan able funds in the credit market. The sources of supply and demand of loan able funds are discussed as under: -

A. Supply of Loan able Funds: These are the main sources of loan able of supply funds.

1. Savings: It is most important source of loan able funds. The amount saved varies at various rate of interest.

2. Dishoarding: A money lender may dishoard money from his stock of previous period. The more amounts will be dishoarded at higher rate of interest and vice versa.

3. Bank Credit: The credit creation is an important function of commercial banking system. This new created money adds to the supply of loan funds.

B. Demand for loan able funds:
There are three fields of the demand for loan able funds.

1. Investment: The business firms borrow money for purchasing new capital goods buildings etc. The loan able funds are demanded up to the points at which the expected rates of return on capital goods equal the rate of interest.

2. Consumption: If individual wish to purchase in excess of their current incomes, they demand loan able funds.

3. Hoarding: The people desire to hoard money in liquid form. A saver can be said to be supplying funds and also demanding them to satisfy his liquidity preference. So, the demand for money is interest elastic and its demand curve negatively sloped.

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