A local business owner is considering taking out a loan to expand operations. However, recent news reports have shown a downturn in the economy, causing widespread pessimism among investors. How is this likely to affect the interest rates in the loanable funds market?

When the economy slows, investors become more cautious and want higher returns to compensate for risk, so they demand more money for lending. This increased demand for funds pushes up the price of borrowing, which is the interest rate. In the loanable funds market, the supply of savings may also shrink because people save less when uncertain, further tightening funds and raising rates. For example, if a small business wants a loan, the bank will charge a higher rate to reflect the greater risk and tighter supply of funds. Thus, a downturn typically leads to higher interest rates.