Question

What is the impact of the government's transition from fiscal balance to fiscal revenue and expenditure on the market for loanable funds? Try to plot and explain the impact on the supply or demand of loanable funds and the amount of interest rates and loanable funds.

Answer 1

If the government is maintaining fiscal balance, then public saving is 0 and national saving will include only private saving. In case the government transforms itself to now be open to a fiscal deficit or surplus, there can be changes in the market for loanable funds

If government experiences a deficit, public saving would fall. This decreases national savings and so supply curve of loanable funds shifts left. Interest rate rises and level of loanable funds demanded and supplied fall in tandem

If government experiences a surplus public saving would rise. This increases national savings and so supply curve of loanable funds shifts right. Interest rate falls and level of loanable funds demanded and supplied rise in tandem