If the government wants to increase the amount of savings in the economy,how should it alter...

If the government wants to increase the amount of savings in the economy,how should it alter government spending?What effect will this action have on the interest rate in the economy?(Use the appropriate graph to help demonstrate the effect.)

Expert Solution

When the government want to increase the amount of savings in the economy, the government should adopt contractionary fiscal policy. The government can increase taxes or reduce government spending to reduce the borrowing from the loanable funds market. When the government reduces spending, the Aggregate Demand (Consumption + Government spending + Investment +Net Exports) falls due to fall in government spending. This result in Aggregate Demand curve to shift to the left from D to D1 (Figure below).

The resulting balanced fiscal budget will increase the savings available to private players in loanable funds market. Excess savings in loanable funds market decrease the interest rate in the economy. Increase in savings will shift the supply toward right from S to S1 resulting in fall in interest rate or (decrease the demand for loanable funds)

LOANABLE FUNDS MARKET

Rahul Sunny answered 8 months ago

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