Croce keynesiana

In a closed economy, total planned spending is called planned aggregate expenditure, or PAE. It includes consumption, investment, and government spending on goods and services.

The graph shows PAE against real output. The 45-degree line shows all points where output equals planned spending. This is where equilibrium is established, and the resulting graph is often referred to as the Keynesian cross.

Now, let’s see how interest rates affect this.

High interest rates increase borrowing costs, making many investment projects unprofitable. As a result, firms reduce investment, lowering total PAE.

This shifts the PAE curve downward, reducing the equilibrium output level.

For example, imagine a coffee shop that wants to expand. High interest rates make borrowing expensive, delaying the shop's expansion. As a result, investment falls, PAE decreases, and equilibrium output declines.

On the other hand, falling interest rates make borrowing cheaper, encouraging the coffee shop to expand, leading to increased PAE and equilibrium output through changes in investment and spending.

Overall, the Keynesian cross shows how interest rates affect output by changing investment and shifting the PAE curve.