What Shifts Loanable Funds

The loanable funds market has a supply curve, from savers, and a demand curve, from borrowers, mostly firms wanting to invest. Anything that makes firms want to borrow more at every interest rate shifts demand right. An investment tax credit does exactly this: it makes new equipment cheaper to buy, so firms want more loanable funds at any given rate. With demand now exceeding supply at the old rate, the real interest rate gets bid up until the market clears again. That higher rate isn't just a cost for the firms chasing the credit; it raises borrowing costs for everybody else in the market too, since there's one real interest rate for all borrowers.

Supply shifts work the same logic from the saver's side. If households decide to save a much bigger share of income, the supply of loanable funds shifts right, and the real interest rate falls. A lower real rate makes borrowing cheaper, which can pull investment demand up along the demand curve. But notice the word can: nothing forces firms to actually want more funds just because funds are cheaper. If investment demand is weak or firms see no good projects, the extra saving sits there with little effect on growth. More saving changes the price of funds, not automatically the appetite to invest.

A government budget deficit enters the picture as new demand, separate from private investment. The government needs to borrow to cover the gap between spending and tax revenue, so at every real interest rate, total quantity demanded is private investment demand plus the deficit amount. Graphically this shifts the whole demand curve right by the size of the deficit, raising the equilibrium real rate and tending to crowd out some private investment.