Closed Economy.

In a dosed economy, we know that investment must equal private saving plus the government surplus. We simplify by assuming that taxes, government spending, and: private saving are independent of interest rates. Hence, cliometric saving (public and private) is a Guantanamo at full employment. ‘ By contrast, as we in chapter 22, investment is very sensitive to the interest rate. Higher interest rates reduce spending on housing and business plant and equipment. We therefore write our investment schedule as I(r) to indicate that investment depends upon the real interest rate.

Figure 30-7 shows how national saving and investment are equilibrated in a full-employment . dosed economy. The saving and investment schedules determine an interest rate at r* with healthy levels of saving and investment.

Now suppose that the government increases its purchases, increasing the government deficit or reducing the surplus. This will shift the saving schedule to the left to S + T – G ‘. As a result, the real interest rate increases to equilibrate saving and investment, and the level of investment falls. The major point is that a higher government deficit lours investment in the full.

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