The loanable funds theory is generally regarded as superior to the classical theory of interest because it offers a more comprehensive and realistic explanation of how interest rates are determined.

The classical theory, grounded in real factors, argues that the interest rate is determined solely by the intersection of savings supply and investment demand. Interest is seen as the reward for abstaining from consumption and the cost of using productive capital. In this framework, money plays no independent role, being treated as a mere veil. However, the theory assumes full employment, neglects monetary influences, and is often criticized as indeterminate, since both saving and investment depend on income, which is not explicitly explained within the model.

The loanable funds theory, in contrast, integrates both real and monetary elements. The supply of loanable funds comes not only from current savings but also from dishoarding (release of past savings) and credit creation by banks. Similarly, the demand for loanable funds includes both investment needs and the desire to hoard money. By incorporating money supply, liquidity preferences, and financial markets, the theory offers a fuller account of interest rate determination.

This broader approach explains how factors such as monetary policy, shifts in money demand, and government borrowing (budget deficits) influence interest rates. It also views interest not just as a return on capital but as the price for borrowing and lending funds in financial markets.

Thus, by blending real and monetary forces, the loanable funds theory provides greater realism and analytical strength than the purely real-focused classical theory.