Suppose Congress institutes an investment tax credit. What would happen in the market for loanable funds? (A) The interest rate and investment would fall. (B) The interest rate and investment would rise. (C) The interest rate would rise and investment would fall. (D) None of the above is necessarily correct.

In the loanable funds market, the supply is made up of the savings that all of us deposit in the banks and that they then lend; while the demand is equivalent to the amount of real loans made to firms and households (borrowing), which use them to make investments. On the other hand, the price of loans is the real interest rate (you can see the graph attached, it´s the first one).

An Investment Tax Credit is a fiscal stimulus that consists of a reduction in corporate taxes based on the cost and useful life of certain assets. That way, firms will have incentives to invest more, especially in the purchase of new assets, which will expand their chances of enjoying the tax benefit.

This translates as follows in the loanable funds market: to carry out their investments, companies will borrow more resources, which will increase the demand for loanable funds (an increase in demand can be illustrated by a shift in the demand curve to the right). In turn, this will raise the real interest rate. Theoretically, this means that the higher the interest rate, the more expensive it is to borrow.

(You can see the graph attached as well, it´s the second one).