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Australia’s budget is set to return to a surplus of $4.1 billion in the 2019/20 financial...

Australia’s budget is set to return to a surplus of $4.1 billion in the 2019/20 financial year, according to the Mid-Year Economic and Fiscal Outlook.

- Suppose that the said surplus eventuates as predicted. Using a loanable funds graph, explain the effects of a government budget surplus on the loanable funds market. Explain how it effects the quantity of loanable funds, real interest rate and investment.

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Answer #1

A budget surplus reduces government borrowing for deficit financing purposes. Since borrowing is demand for loanable funds, lower borrowing reduces demand for loanable funds, shifting demand curve leftward. Supply curve remaining unchanged, this decreases real interest rate and decreases the quantity of loanable funds (investment).

In following graph, D0 and S0 are initial demand and supply curves for loanable funds intersecting at point A with initial interest rate r0 and quantity of loanable funds (investment) Q0. As D0 shifts left to D1, it intersects S0 at point B with lower interest rate r1 and lower quantity of loanable funds (investment) Q1.

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