Budget Surplus: The Real Rate Falls
The government collects more in taxes than it spends, adding public saving to the market, so supply shifts right and the real interest rate falls.
Budget Surplus: The Real Rate Falls
Loanable Funds MarketThe government collects more in taxes than it spends, adding public saving to the market, so supply shifts right and the real interest rate falls.
Equilibrium at Quantity of Loanable Funds 73, Real Interest Rate (%) 5
Start at Equilibrium
The market starts in equilibrium with the real interest rate on the vertical axis and the quantity of loanable funds on the horizontal axis. National saving, the supply side here, is private saving plus public saving. Public saving is simply tax revenue minus government spending, so a government running a balanced budget contributes nothing to the pool either way.
Now try it yourself: shift the curves in a graded FRQ drill, or open this graph in the free sandbox.
Students predict what happens before the graph moves. No accounts, nothing graded.
Budget Surplus: The Real Rate Falls, step by step
- 1
Start at Equilibrium
The market starts in equilibrium with the real interest rate on the vertical axis and the quantity of loanable funds on the horizontal axis. National saving, the supply side here, is private saving plus public saving. Public saving is simply tax revenue minus government spending, so a government running a balanced budget contributes nothing to the pool either way.
- 2
The Budget Swings to Surplus
Revenue now exceeds spending, so public saving turns positive and the Treasury lends the difference back to the market rather than absorbing funds from it. A government that borrows adds to the demand for funds, but a government that saves adds to the supply, and this year it is saving. National saving rises at every real interest rate, so the supply of loanable funds shifts right. Private saving habits have not changed; the whole shift comes from the public side.
- 3
The Real Interest Rate Falls
With more funds chasing the same set of borrowers, the equilibrium slides down along the demand curve. The real interest rate falls and the equilibrium quantity of funds rises. Investment demand did not shift: firms are simply moving to a cheaper point on the curve they were always on.
- 4
Private Investment Is Crowded In
At the lower real interest rate, projects that were not worth financing before now clear the hurdle, so the quantity of private investment demanded rises. Economists call this crowding in, the reverse of the crowding out a deficit causes when its borrowing pushes the real interest rate up. The surplus does not fund investment directly; it works entirely through the lower real interest rate.
Where it ends up
A budget surplus adds public saving to the loanable funds market, lowering the real interest rate and raising the quantity of funds borrowed and invested.
Now draw it yourself
Same graph, graded on whether you move the right curve and leave the rest alone.
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