A budget surplus increases the supply of loanable funds. A change in the government budget balance represents a change in public saving and, thereby, in the supply of loanable funds. Because the budget deficit does not influence the amount that households and firms want to borrow to finance investment at any given interest rate, it does not alter the demand for loanable funds. Shift in the supply curve:
When the government runs a budget surplus, public saving is positive, and this increases national saving. Government faces various options for what to do with budget-surplus funds. One option, if the government has run budget deficits in the past, is to use surplus funds to retire the debt accumulated from those deficits. This budget surplus, or public saving, contributes to national saving. Thus, the supply curve shifts to the right from S1 to S2, as shown in the diagram, which shows an increase in the supply of loanable funds. In the figure when the budget surplus increases the supply of loanable funds, the interest rate reduces from 5 percent to 4 percent. This lower interest rate than alters the behavior of the households and the firms that participate in the loan market. In particular, many demanders of loanable funds are encouraged by the lower interest rate. More families buy new homes, and more firms choose to build new factories. Thus, a budget surplus increases the supply of loanable funds, reduces the interest rate, and stimulates investment.