Download Loanable funds - FMT-HANU

Macroeconomics
Lecture 5
Saving, Investment &
the Financial System
Chapter 26
Lecture Objectives
Learn about financial institutions.
 Consider how the financial system is
related to key macroeconomic variables.
 Develop a model of the supply and
demand for loanable funds.
 Use the loanable funds model to analyze
various government policies.
 Consider how budget deficits and
surpluses affect the economy.

The Financial System
Consist of institutions that help to
match one person’s saving with
another person’s investment.
 Move the economy’s scarce resources
from savers to borrowers.

Financial Institutions

Financial institutions:

Categories
Financial Institutions
Financial Markets

Financial markets:

Categories
Financial Institutions
Financial Intermediaries

Financial intermediaries

Categories
Financial Markets
Bond Market
A
bond: a certificate of
indebtedness that specifies
obligations of the borrower
to the holder of the bond.
Debt
financing: sale of bond
to raise money
IOU
Financial Markets
Bond Market

Characteristics of a Bond:
 Term
 Credit Risk
 Tax Treatment
Financial Markets
Stock Market

Stock



represent ownership in a firm  a claim to
the profits that the firm makes.
offer both higher risk and potentially higher
returns in comparison with bonds
Equity financing

sale of stock to raise money.
Financial Intermediaries
Banks
Take deposits from people who want to
save
 Make loans from deposits to people who
want to borrow.



pay depositors interest on their deposits
charge borrowers slightly higher interest on
their loans.
Financial Intermediaries
Banks

Create a medium of exchange by allowing
people to write checks against their
deposits.
 A medium of exchanges: an item that people
can easily use to engage in transactions,
facilitates the purchases of goods and
services.
Financial Intermediaries
Mutual Funds
A
mutual fund (USA)/ managed fund
(Australia): an institution that sells shares
to the public and uses the proceeds to buy
a selection, or portfolio, of various types of
stocks, bonds, or both.
 allow people with small amounts of
money to easily diversify.
Financial Intermediaries
Others
 Credit
unions
 Pension funds
 Insurance companies
 Loan sharks
Financial Instruments in the US
US household wealth (2014)
Saving and Investment in the
National Income Accounts
GDP = total income = total expenditure
Y = C + I + G + NX
Some Important Identities
A closed economy without
international trade:
Y=C+I+G
Some Important Identities

Subtract C and G from both sides of the
equation:
Y – C – G =I

National saving, or just saving (S): total
income in the economy after paying for
consumption and government purchases
and is called
Some Important Identities

Substituting S for Y-C-G
S=I

National saving, or saving:
S=I
S=Y–C–G
S = (Y – T – C) + (T – G)
where “T” = taxes - transfers
Private Saving & Public Saving

Private saving: the amount of income that
households have left after paying their
taxes and paying for their consumption.

Public saving: the amount of tax revenue
that the government has left after paying
for its spending.
Surplus and Deficit

T>G:
budget surplus

G>T:
budget deficit
Saving and Investment
 For
the economy as a whole, saving
must be equal to investment.
S=I
Saving and Investment in the
National Income Accounts

National Saving or Saving:
Y - C - G = I = S or
S = (Y - T - C) + (T - G)
where “T” = taxes - transfers

Two components of national saving:
 Private Saving
 Public Saving
Open economy
NX= NCO = NCI
Y=C+I+G+NX
I=(Y-T-C)+ (T-G)-NCO
The Market for Loanable Funds
Market for loanable funds: coordinate the
economy’s saving and investment.
 Loanable funds: all income that people
have chosen to save and lend out, rather
than use for their own consumption.

Supply and Demand
for Loanable Funds

The supply of loanable funds

The demand for loanable funds
Supply and Demand
for Loanable Funds

Interest rate: price of the loan.



the amount that borrowers pay for loans
the amount that lenders receive on their
saving.
Interest rate in the market for loanable
funds: real interest rate.
Market for Loanable Funds
Real
Interest
Rate
Supply
E
5%
The equilibrium
of the supply
and demand for
loanable funds
determines the
real interest
rate.
Demand
0
$1,200
Loanable Funds (in
billions of dollars)
Government Policies That
Affect Saving and Investment
 Taxes
and saving
 Taxes and investment
 Government budget deficits
Taxes and Saving

Taxes on interest income
 substantially reduce the future payoff from
current saving and
 reduce the incentive to save.
A
tax decrease
 increases the incentive for households to save
at any given interest rate.
An Increase in the Supply of
Loanable Funds
Interest
Rate
Supply, S1
S2
1. Tax incentives for
saving increase the
supply of loanable
funds...
5%
4%
Demand
2. ...which
reduces the
equilibrium
interest rate...
0
$1,200
Loanable Funds
$1,600
(in billions of dollars)
3. ...and raises the equilibrium quantity of loanable funds.
Taxes and Saving
Change in tax law encouraging saving
 lower interest rates & greater investment

 Supply of loanable funds curve
 Equilibrium interest rate
 Quantity demanded for loanable funds
Taxes and Investment
 An
investment tax credit (tax reduction to
encourage investment)  increase the
incentive to borrow.
 the demand for loanable funds
 the demand curve
 interest rate
 quantity saved
An Increase in the Demand for
Loanable Funds
Interest
Rate
6%
5%
2. ...which
raises the
equilibrium
interest rate...
0
Supply
1. An investment tax
credit increases the
demand for loanable
funds...
D2
Demand, D1
$1,400
$1,200
Loanable Funds
(in billions of dollars)
3. ...and raises the equilibrium
quantity of loanable funds.
Government Budget Deficits

Budget deficit

Government debt
Government Budget Deficits
 Government borrowing to
finance its
budget deficit
 reduce the supply of loanable funds
available to finance investment by
households and firms  Crowding out
 Crowding out: fall in private investment
due to deficit borrowing
The Effect of a Government
Budget Deficit
Interest
Rate
S2
6%
5%
2. ...which
raises the
equilibrium
interest rate...
$800
$1,200
0
3. ...and reduces the equilibrium
quantity of loanable funds.
Supply, S1
1. A budget deficit
decreases the
supply of loanable
funds...
Demand
Loanable Funds
(in billions of dollars)
Government Budget Deficits
budget deficit  decrease the supply of
loanable funds:
A
 Supply curve
 Equilibrium interest rate
 Equilibrium quantity of loanable funds
Government Budget
Deficits and Surpluses

Deficit

Surplus
120%
U.S. government debt
(% of GDP 1970-2007)
100%
80%
60%
40%
20%
0%
1790 1810 1830 1850 1870 1890 1910 1930 1950 1970 1990 2010
Global loanable fund market

Global intergration

Capital mobility

Real Interest rate differences
Global loanable fund market
Lecture Review
Financial Markets and Intermediaries
 Saving and Investment
 Market for Loanable Funds
 Government policies that affect the
economy’s savings and investment
 Government Budget deficits and surplus
