1、Copyright 2004 South-WesternSaving, Investment, and the Financial SystemCopyright 2004 South-WesternThe Financial System The consists of the group of institutions in the economy that help to match one persons saving with another persons investment. It moves the economys scarce resources from savers
2、to borrowers.Copyright 2004 South-WesternFINANCIAL INSTITUTIONS IN THE U.S. ECONOMY The financial system is made up of financial institutions that coordinate the actions of savers and borrowers. Financial institutions can be grouped into two different categories: financial markets and financial inte
3、rmediaries.Copyright 2004 South-WesternFINANCIAL INSTITUTIONS IN THE U.S. ECONOMY Financial Markets Stock Market Bond Market Financial Intermediaries Banks Mutual FundsCopyright 2004 South-WesternFINANCIAL INSTITUTIONS IN THE U.S. ECONOMY Financial markets are the institutions through which savers c
4、an directly provide funds to borrowers. Financial intermediaries are financial institutions through which savers can indirectly provide funds to borrowers.Copyright 2004 South-WesternFinancial Markets The Bond Market A bond is a certificate of indebtedness thatspecifies obligations of the borrower t
5、o the holder of the bond. Characteristics of a Bond Term: The length of time until the bond matures. Credit Risk: The probability that the borrower will fail to pay some of the interest or principal. Tax Treatment: The way in which the tax laws treat the interest on the bond. Municipal bonds are fed
6、eral tax exempt.IOUCopyright 2004 South-WesternFinancial Markets The Stock Market Stock represents a claim to partial ownership in a firm and is therefore, a claim to the profits that the firm makes. The sale of stock to raise money is called equity financing. Compared to bonds, stocks offer both hi
7、gher risk and potentially higher returns. The most important stock exchanges in the United States are the New York Stock Exchange, the American Stock Exchange, and NASDAQ.Copyright 2004 South-WesternFinancial Markets The Stock Market Most newspaper stock tables provide the following information: Pri
8、ce (of a share) Volume (number of shares sold) Dividend (profits paid to stockholders) Price-earnings ratioCopyright 2004 South-WesternFinancial Intermediaries Financial intermediaries are financial institutions through which savers can indirectly provide funds to borrowers.Copyright 2004 South-West
9、ernFinancial Intermediaries Banks take deposits from people who want to save and use the deposits to make loans to people who want to borrow. pay depositors interest on their deposits and charge borrowers slightly higher interest on their loans.Copyright 2004 South-WesternFinancial Intermediaries Ba
10、nks Banks help create a medium of exchange by allowing people to write checks against their deposits. A medium of exchanges is an item that people can easily use to engage in transactions. This facilitates the purchases of goods and services.Copyright 2004 South-WesternFinancial Intermediaries Mutua
11、l Funds A mutual fund is an institution that sells shares to the public and uses the proceeds to buy a portfolio, of various types of stocks, bonds, or both. They allow people with small amounts of money to easily diversify.Copyright 2004 South-WesternFinancial Intermediaries Other Financial Institu
12、tions Credit unions Pension funds Insurance companies Loan sharksCopyright 2004 South-WesternSAVING AND INVESTMENT IN THE NATIONAL INCOME ACCOUNTS Recall that GDP is both total income in an economy and total expenditure on the economys output of goods and services:Copyright 2004 South-WesternSome Im
13、portant Identities Assume a one that does not engage in international trade:Copyright 2004 South-WesternSome Important Identities Now, subtract C and G from both sides of the equation: The left side of the equation is the total income in the economy after paying for consumption and government purcha
14、ses and is called national saving, or just saving (S).Copyright 2004 South-WesternSome Important Identities Substituting S for Y - C - G, the equation can be written as:Copyright 2004 South-WesternSome Important Identities National saving, or saving, is equal to:Copyright 2004 South-WesternThe Meani
15、ng of Saving and Investment National Saving National saving is the total income in the economy that remains after paying for consumption and government purchases. Private Saving Private saving is the amount of income that households have left after paying their taxes and paying for their consumption
16、.Copyright 2004 South-WesternThe Meaning of Saving and Investment Public Saving Public saving is the amount of tax revenue that the government has left after paying for its spending.Copyright 2004 South-WesternThe Meaning of Saving and Investment Surplus and Deficit If T G, the government runs a bud
17、get surplus because it receives more money than it spends. The surplus of T - G represents public saving. If G T, the government runs a budget deficit because it spends more money than it receives in tax revenue.Copyright 2004 South-WesternThe Meaning of Saving and Investment For the economy as a wh
18、ole, saving must be equal to investment. Copyright 2004 South-WesternTHE MARKET FOR LOANABLE FUNDS Financial markets coordinate the economys saving and investment in the Copyright 2004 South-WesternTHE MARKET FOR LOANABLE FUNDS The market for loanable funds is the market in which those who want to s
19、ave supply funds and those who want to borrow to invest demand funds.Copyright 2004 South-WesternTHE MARKET FOR LOANABLE FUNDS refers to all income that people have chosen to save and lend out, rather than use for their own consumption.Copyright 2004 South-WesternSupply and Demand for Loanable Funds
20、 The supply of loanable funds comes from people who have extra income they want to save and lend out. The demand for loanable funds comes from households and firms that wish to borrow to make investments.Copyright 2004 South-WesternSupply and Demand for Loanable Funds The interest rate is the price
21、of the loan. It represents the amount that borrowers pay for loans and the amount that lenders receive on their saving. The interest rate in the market for loanable funds is the real interest rate.Copyright 2004 South-WesternSupply and Demand for Loanable Funds Financial markets work much like other
22、 markets in the economy. The equilibrium of the supply and demand for loanable funds determines the real interest rate.Figure 1 The Market for Loanable FundsLoanable Funds(in billions of dollars)0InterestRateSupplyDemand5%$1,200Copyright2004 South-WesternCopyright 2004 South-WesternSupply and Demand
23、 for Loanable Funds Government Policies That Affect Saving and Investment Taxes and saving Taxes and investment Government budget deficitsCopyright 2004 South-WesternPolicy 1: Saving Incentives Taxes on interest income substantially reduce the future payoff from current saving and, as a result, redu
24、ce the incentive to save.Copyright 2004 South-WesternPolicy 1: Saving Incentives A tax decrease increases the incentive for households to save at any given interest rate. The supply of loanable funds curve shifts to the right. The equilibrium interest rate decreases. The quantity demanded for loanab
25、le funds increases.Figure 2 An Increase in the Supply of Loanable FundsLoanable Funds(in billions of dollars)0InterestRateSupply, S1S22. . . . whichreduces theequilibriuminterest rate . . .3. . . . and raises the equilibriumquantity of loanable funds.Demand1. Tax incentives forsaving increase thesup
26、ply of loanablefunds . . .5%$1,2004%$1,600Copyright2004 South-WesternCopyright 2004 South-WesternPolicy 1: Saving Incentives If a change in tax law encourages greater saving, the result will be lower interest rates and greater investment.Copyright 2004 South-WesternPolicy 2: Investment Incentives An
27、 investment tax credit increases the incentive to borrow. Increases the demand for loanable funds. Shifts the demand curve to the right. Results in a higher interest rate and a greater quantity saved.Copyright 2004 South-WesternPolicy 2: Investment Incentives If a change in tax laws encourages great
28、er investment, the result will be higher interest rates and greater saving.Figure 3 An Increase in the Demand for Loanable FundsLoanable Funds(in billions of dollars)0InterestRate1. An investmenttax creditincreases thedemand for loanable funds . . .2. . . . whichraises theequilibriuminterest rate .
29、. .3. . . . and raises the equilibriumquantity of loanable funds.SupplyDemand, D1 D25%$1,2006%$1,400Copyright2004 South-WesternCopyright 2004 South-WesternPolicy 3: Government Budget Deficits and Surpluses When the government spends more than it receives in tax revenues, the short fall is called the
30、 budget deficit. The accumulation of past budget deficits is called the government debt.Copyright 2004 South-WesternPolicy 3: Government Budget Deficits and Surpluses Government borrowing to finance its budget deficit reduces the supply of loanable funds available to finance investment by households
31、 and firms. This fall in investment is referred to as crowding out. The deficit borrowing crowds out private borrowers who are trying to finance investments.Copyright 2004 South-WesternPolicy 3: Government Budget Deficits and Surpluses A budget deficit decreases the supply of loanable funds. Shifts
32、the supply curve to the left. Increases the equilibrium interest rate. Reduces the equilibrium quantity of loanable funds.Figure 4: The Effect of a Government Budget DeficitLoanable Funds(in billions of dollars)0InterestRate3. . . . and reduces the equilibriumquantity of loanable funds.S22. . . . wh
33、ichraises theequilibriuminterest rate . . .Supply, S1Demand$1,2005%$8006%1. A budget deficitdecreases thesupply of loanablefunds . . .Copyright2004 South-WesternCopyright 2004 South-WesternPolicy 3: Government Budget Deficits and Surpluses When government reduces national saving by running a deficit
34、, the interest rate rises and investment falls.Copyright 2004 South-WesternPolicy 3: Government Budget Deficits and Surpluses A budget surplus increases the supply of loanable funds, reduces the interest rate, and stimulates investment.Figure 5 The U.S. Government DebtPercentof GDP179018101830185018
35、70189019101930195019701990RevolutionaryWar2010CivilWarWorld War IWorld War II020406080100120Copyright2004 South-WesternCopyright 2004 South-WesternSummary The U.S. financial system is made up of financial institutions such as the bond market, the stock market, banks, and mutual funds. All these inst
36、itutions act to direct the resources of households who want to save some of their income into the hands of households and firms who want to borrow.Copyright 2004 South-WesternSummary National income accounting identities reveal some important relationships among macroeconomic variables. In particula
37、r, in a closed economy, national saving must equal investment. Financial institutions attempt to match one persons saving with another persons investment.Copyright 2004 South-WesternSummary The interest rate is determined by the supply and demand for loanable funds. The supply of loanable funds come
38、s from households who want to save some of their income. The demand for loanable funds comes from households and firms who want to borrow for investment.Copyright 2004 South-WesternSummary National saving equals private saving plus public saving. A government budget deficit represents negative public saving and, therefore, reduces national saving and the supply of loanable funds. When a government budget deficit crowds out investment, it reduces the growth of productivity and GDP.
