Final answer:
In a recession, the demand for loanable funds decreases as businesses and consumers cut back on borrowing due to economic uncertainty, reduced incomes, and higher interest rates.
Step-by-step explanation:
When the economy enters a recession, the demand for loanable funds typically decreases. During a recession, businesses are less likely to invest in new projects due to economic uncertainty and reduced profitability expectations, which diminishes the demand for loans. Similarly, consumers hesitate to take out large loans for items like homes and cars, leading to a drop in consumer borrowing. Consequently, higher interest rates during a recession can make it more attractive for firms with money to invest in financial markets rather than physical capital, further reducing the demand for loanable funds. Additionally, with the loss of jobs and decline in incomes, as seen during the Great Recession of 2008-2009, there is a marked decrease in consumption and investment, causing a decline in aggregate demand overall.