In the long run, an increase in the demand for investment pushes the real interest rate, encourages saving by households, and leads to a future growth rate of potential output.

Question

Quizplus · Accepted Answer

According to the loanable funds theory, an increase in demand for investment will lead to an increase in the real interest rate as borrowers are willing to pay more to borrow funds. This, in turn, encourages households to save more as they earn a higher return on their savings. As more funds are available for investment, the economy can increase its capital stock, leading to a higher future growth rate of potential output.

In the Long Run, an Increase in the Demand for Investment