Final answer:
Lower real interest rates decrease the cost of borrowing, encouraging companies to finance investment projects and consumers to spend on major items, leading to an increase in investment spending.
Step-by-step explanation:
A reduction in the real interest rate is likely to increase investment spending because it decreases the cost of borrowing. Businesses are more inclined to finance new investment projects when it is cheaper to borrow money. For instance, a company might take on new projects like expanding their facilities or upgrading equipment if interest rates are lower. This is because lower interest rates make it less expensive to fund these projects through loans.
On the flip side, higher interest rates make borrowing more expensive, and thus, companies may delay or cancel investment in new projects because the cost of finance is too high. Similarly, higher interest rates make it more attractive for firms to place their funds in financial investments rather than investing in physical capital. Furthermore, consumers are discouraged from borrowing for big-ticket items like houses and cars when interest rates are high, reducing consumption and investment spending. Therefore, a reduction in interest rates, as a result of expansionary monetary policy, tends to increase business investment and consumer spending on significant purchases.