The model of the market for loanable funds shows that an investment tax credit will cause interest rates to rise and investment to rise. Yet we also suppose that higher interest rates lead to lower investment. How can these two conclusions be reconciled?
The claim that an increase in the interest rate decreases investment supposes that only the interest rate changes and everything else is constant. The investment tax credit causes investment to rise at each interest rate. As firms want to borrow more the interest rate will rise. The rise in interest rates does make investment less than it would otherwise be, but unless the supply of loanable funds is vertical, the increase in investment demand from the tax credit is larger than the decrease in investment demand from the rising interest rate.
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