Interest rates and tax policy pull household and firm behaviour in the same direction — raising either one cools spending and investment, lowering either stimulates it.
spending ~ 1/interest_rate
investment ~ 1/(interest_rate + tax_rate)
- Household agents — consumer agents whose spending responds to interest rates.
- Firm agents — producer agents whose investment responds to borrowing cost and tax.
- Interest rate — the policy rate set by the central bank, the primary monetary lever.
- Tax rate — the fiscal lever affecting after-tax returns to investment and spending.
This trade-off is exactly what central banks and finance ministries weigh every policy meeting — tightening cools an overheating economy but also slows real investment.