Final answer:
A decline in the interest rate increases investment spending, which shifts the aggregate demand curve to the right due to higher overall demand, and this can lead to inflation if it exceeds potential GDP.
Step-by-step explanation:
An increase in investment spending caused by a decline in the interest rate will shift the aggregate demand curve to the right. This is because lower interest rates make borrowing cheaper, which encourages firms to invest more in business activities as they expect higher profit opportunities. Consequently, the increase in investment spending stimulates greater overall demand in the economy, shifting the aggregate demand (AD) curve rightward. It can potentially lead to higher income and price levels, and if this shift goes beyond the potential GDP, it may cause inflation.
It's important to note that a shift in the aggregate demand curve reflects a change in the total amount of goods and services demanded at every price level. It should not be confused with movement along a given AD curve, which occurs when there is a change in the quantity demanded as the result of a change in the price level, rather than because of a change in overall spending behavior.