Final answer:
If the public consumes less and the government spends less, the supply of loanable funds in the economy increases. This generally leads to lower interest rates, as there is a larger supply of capital available for investment, and less need for government borrowing.
Step-by-step explanation:
In economics, the supply of loanable funds is influenced by the level of savings in the economy and government spending. If the public consumes 200 billion less relative to the previous year and the government spends 100 billion less, it is expected that the supply of loanable funds would increase. Less consumption implies higher savings, leading to a greater supply of loanable funds. Likewise, with the government spending less, it theoretically needs to borrow less from the financial capital markets, which means there will be more loanable funds available for other borrowers.
Looking at the impact on interest rates in financial markets, when the government borrows less and public savings increase, there is less competition for funds.
According to economic theory and historical precedent as exemplified in the mid-1980s and the period after the Great Recession, an increase in the supply of loanable funds typically leads to lower interest rates, since there is more capital available for investment. This is compatible with the basic supply and demand model where an increase in supply, with demand remaining constant, results in a lower equilibrium price—in this case, the "price" being the interest rate.
Private domestic savings would need to rise to account for the decrease in spending. If the government cuts back on its deficit spending, this alters the supply and demand equilibrium for loanable funds, which could potentially lead to lower interest rates, all else being equal.