Funds flow into the financial sector as a result of household savings and borrowing from the rest of the world. Funds flow from the government sector (to finance the government deficit) and to the firm sector to finance investment. Toolkit: Section 16.4 “The Credit (Loan) Market (Macro)” You can review the credit market in the toolkit. The Credit Market The supply of loans in the credit market comes from (1) private savings of households and firms, (2) savings or borrowing of governments, and (3) savings or borrowing of foreigners. Households generally respond to an increase in the real interest rate by saving more. Higher real interest rates also encourage foreigners to send funds to the domestic economy. National savings are defined as private savings plus government savings (or, equivalently, private savings minus the government deficit). The total supply of savings is therefore equal to national savings plus the savings of foreigners (that is, borrowing from other countries). The demand for credit comes from firms who borrow to finance investment.
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