Download Chapter 10

Econ 2301
Macroeconomics
Dr. Jacobson
Mr. (Coach) Stuckey
Chapter 10
Savings
Investment Spending
and the
Financial System
National
Savings
What is it?
 National
Savings is the total income in
the economy that remains after paying
for consumption and government
purchases.
 The portion of the nation’s income that
is not consumed.
Equation for National Savings
S=Y-C-G
GDP Y=C+I+G
S=I
S=National Savings, Y=GDP, C=Consumption, G=Government Purchases, I=Investment
Savings=Investment
 Savings
has to equal investments for
the economy as a whole, but not for
every individual.
 The bond market, stock market, banks,
mutual funds and other financial
markets take the nation’s savings and
direct it to the nation’s investment.
National Savings
Represents resources available for
investment to do things like replace old
factories and equipment, or to buy
more and better capital goods.
 Plays a major role in our nation’s longterm economic growth and future living
standards.
 Higher savings and investment
contribute to increased productivity
and stronger economic growth.

The United States net national savings is
less than 1% of the GDP

The net national savings rate has not been this low since the Great Depression.
Positivity of National Savings
Savings
is the main
source of funds available
for domestic investment
in new capital goods.
Ways to Higher National Savings
Tax
Reforms
Budget Deficit
Social Security
Tax Reforms
 Make
the tax code simpler,
more fair, and to further
promote savings, and job
creation
 Reduce the bias against
savings and investment
inherent in the current
system.
Budget Deficit
Create
a plan to reduce
the deficit over time
relative to the size of the
economy.
Restrain government
spending growth
Social Security Reform
 Restoring
Social Security to
sustainable solvency and
increasing saving are
intertwined national goals.
 The way in which Social Security
is reformed will influence both
the magnitude and timing of any
increase in national savings.
Negativity of National Savings
National
savings has been in
the red in past years.
The net national savings rate
has not been this low since
the Great Depression.
Things are not looking too
good for the future either.
National debt sky high, savings
not.
Fear
and obsession regarding
consumer spending continues,
the fact is that the beginning
of the 21st century has not
been troubled with excessive
savings, but by a serious
dearth in savings.
Consequences of Negative
Savings
Negative
savings rate implies
a negative trade balance.
American households are
whittling down their wealth.
Negative national savings
means that the nation is not
accumulating capital
How Many of You Would
Like to Either Start Your
Own Business or Take
Over a Family Business?
Lack of Money or Not
Enough Money is the
Cause of Most Start-up
Businesses Going Broke.
Many People Have Great
Ideas and Even Great
Products That Can Not
Make a Go of It. Why?
Usually Implementation!
Implementation
Usually Means Money or
Lack thereof.
Where Can One Go To
Get the Necessary
Capital?
Places to Get Capital
Money From Friends.
 Mortgage Your House.
 Relatives.
 Sell Assets.
 Banks.
 Venture Capitalists.
 Sell Stock.
 Find Investors.

In the Last Chapter We
Looked at the Various
Ways for a Country to
Increase its Production.
When People Start
New Businesses Can
Not That Increase a
Nations GDP?
In this Chapter We are
Going to Explore the
Various Methods Nations,
Companies and
Individuals Use to Either
Raise Capital or Invest.
In Short:
What is the Engine
Driving Production With
the Needed Capital?
In the Last Chapter We
Saw How Savings and
Investment Are Key
Ingredients to Long Term
Economic Growth.
In an Economy There Are:
Savers- People Who Spend
Less Then They Earn.
Borrowers- People Who
Spend More Than They Earn.
The Financial System Is
the Various Institutions
That Brings Savers and
Borrowers Together.
The Financial SystemThe Group of Institutions in
The Economy That Help to
Match One Person’s Savings
With Another Person’s
Investment.
How Does the
Financial System
Work?
Financial Institutions Can Be
Grouped Into Two
Categories:
1. Financial Markets, and
2. Financial Intermediaries.
1. Financial Markets
Financial Markets Are the
(Financial) Institutions
Through Which Savers
Can Directly Provide
Funds to Borrows.
The Two Most Important
Financial Markets in the
U.S. Economy Are the
Bond Market and the
Stock Market.
A BondIs a Certificate of
Indebtedness That
Specifies the Obligations
of the Borrower To the
Holder of the Bond.
In Simplest Terms A Bond
Can Be Considered A
Loan.
It is Usually Issued by
Either a Corporation or
The Government.
Bonds:
Because They Are A Loan
(or IOU) They “Usually” Do
Not Include Ownership or a
Right to Share in Growth or
Profits. However, Some Are
Convertible to Stock or May
Include Options To Convert.
Bonds Usually Have A
Date of Maturity and a
Rate of Interest.
However This May Take A
Wide Variety of Forms.
For Example:
Bonds May Be Paid Off Early If
The Issuer Exercises A
Previously Included Option .
They May Not Even Pay
Interest But Simply Discount
the Face Amount of the Bond.
Some Corporate Bonds May
Be Issued With Options to
Purchase Shares of Stock at
a Set Price, or They May Be
Convertible Into Shares of
Common or Preferred Stock.
Bonds Are Rated
According to Their Credit
Risk.
Government Bonds Are
Considered Less Risky
and Therefore Usually
Pay a Lower Interest.
Government BondsMay Be Issued By
Federal, State or Local
Governments and May
Also Have Any Interest
Paid as Being Tax
Exempt.
Important Note:
Bonds May Go Into
Default, Wherein the
Owner May Get Either a
Partial Payment or
Nothing.
The Second Type of
Financial Market is
Called the Stock
Market.
Stock
Represents Partial Ownership
in a Company and Therefore
Has a Claim to the Profits The
Company Makes or a Share of
the Proceeds When and If the
Company is Sold.
The Sale of Stock to Raise
Money is Called Equity
Finance.
The Sale of a Bond to
Raise Money is Called
Debt Finance.
Shares of Stock
May Be Sold Through Either
a Private Offering (Limited).
Or a Public Offering and
Traded on One of the Many
Exchanges.
Stock Prices
The Price of A Share of
Stock is Determined By
Supply and Demand. It is
Influenced By
Expectations, Profits and
the Overall Economy.
Bonds Vs. Stocks
Bonds Usually Are Paid Interest
Plus a Return of the Face
Amount of the Bond.
Stock Prices Vary As Does the
Company’s Profits And the
Market. There is No Guarantee of
A Return of Investment.
2. Financial Intermediaries
The Second Category Besides
Financial Markets is Called
Financial Intermediaries That Are
Financial Institutions Through
Which Savers Can Indirectly
Provide Funds to Borrowers.
Financial Intermediaries
Two of the Most
Important Financial
Intermediaries Are Banks
and Mutual Funds.
Other Financial
Intermediaries
Savings
Banks.
Savings and Loan.
Life-Insurance-Companies.
Pension Funds.
Money Market Funds.
Credit Unions.
Banks
Banks Are Financial
Intermediaries Who Take
Deposits From People who Want
to Save and Use These Deposits
to Make Loans to People who
Want to Borrow.
BanksTake the Savers Deposits
and Pay Them an Interest
and Then Charge the
Borrowers A Higher Interest
on Their Loans.
Banks Also Facilitate
Trading By Establishing a
Medium of Exchange By
Making Money Available.
A Mutual Fund
Is 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 Stocks and
Bonds.
The Shareholder of a Mutual
Fund Accepts the Risks and
Returns Associated With the
Portfolio. Like Common
Stock the Shareholder
Benefits When the Value
Increases and Suffers a Loss
When the Value Decreases.
Two Advantages of Mutual
Funds Over Common Stock
Diversification- Mutual Funds
Typically Have a Variety of
Stocks in Their Portfolio.
2. They are Managed By
Professionals Who Are Experts
in Their Field and Able to
Concentrate Their Efforts.
1.
Mutual Funds Also Allow
a Small Investor to Buy a
Number of Different
Stocks That They May
Otherwise Not Be Able to
Afford.
Let Us Again Look At Our
Formula For The GDP
That Included Both The
Total Income and
Expenditures Within the
Borders of The United
States.
You Will (I Hope)
Remember That:
GDP (Y) = Consumption
(C) + Investment (I) +
Government (G) + Net
Export (NX)
Now Let Us Say (For Current
Purposes) That We Have a
Completely Closed Economy
Where There Are No Exports
or Imports. We Know This
Is Not Realistic But Humor
Me.
From Your High School
Math Days You Will
Remember That This Can
Be Changed To Read:
I=Y–C–G
In Other Words I = Y – C – G
Means the Income That is Left
After Paying for Consumption
and Government Purchases. This
Amount is Called National
Savings (or Savings) and Is
Denoted as S. Therefore, S=I Or
Savings Equals Investment.
National Saving
The Total Income In the
Economy That Remains
After Paying for
Consumption and
Government Purchases.
Let Us Now Let T Denote the
Amount the Government
Collects From Households in
Taxes Minus the Amount It
Pays Back to Households in
the Form of Transfer
Payments.
Note:
This is Necessary Because As You
Will Recall Transfer Payments
Are Not Included In the GDP and
Therefore We Must Account For
Them In the Amount the
Government Collects in Taxes.
We Can Now Rewrite Our
Equation as:
S = (Y – T – C) + (T – G)
This Equation Separates National
Savings Into Two Pieces:
Private Savings (Y – T – C) and
Public Savings (T – G)
Private Saving
Y–T–C
The Income That
Households Have Left
After Paying for Taxes
and Consumption.
Public Saving
T–G
The Tax Revenue That
The Government Has Left
After Paying For Its
Spending.
Budget Surplus
An Excess of Tax Revenue
Over Government
Spending.
Budget Deficit
A Shortfall of Tax
Revenue From
Government Spending.
Please Pay
Attention:
as This May Be
Hard to Grasp.
Important Note:
Although in the
Accounting Savings =
Investment For a Nation,
That Does Not Have to Be
True For an Individual.
Example:
If you Earn More Than You Spend On
Consumption and Put Your Money in
a Bank or Some Other Vehicle Such
as Stocks or Bonds Hoping to Get a
Return on Your Money. You Are NOT
“Investing” as Defined By the GDP
as You Are Not Buying Buildings or
Equipment.
How Does Savings =
Investment?
The Saving = Investment
Comes in Where The Bank or
Proceeds From the Stocks or
Bonds May Go to Buy
Buildings and Equipment.
In Short:
Macroeconomists Are
Stealing the Word
“Investment” From What
You and I Use it For and
Changing The Meaning.
Market for Loanable
Funds
The Market in Which
Those Who Want to Save
Supply Funds and Those
Who Want to Borrow to
Invest Demand Funds.
The Market For Loanable
Funds:
For Simplicity, If We Say
That the Economy Has Only
One Financial Market for
Savers and Borrowers to go
to; to Either Deposit Funds
or Get Loans.
Of Course This is Not True
as There Are Many
Different Markets As We
Have Just Seen, Such as;
Banks, Stocks, Bonds,
Mutual Funds, Etc.
The Term Loanable Funds
Refers to All Income That
People Have Chosen to
Save and Lend Out;
Rather Than Use for Their
Own Consumption.
In the Market of Loanable
Funds There is Only One
Interest Rate, Which Is
Both The Return to
Savings and The Cost of
Borrowing.
Market For Loanable Funds
Interest
Rate
Supply
------------------------
5%
0
$1,200
Demand
Loanable Funds
(In Billions of Dollars)
Savings Is the Source
Of The Supply of
Loanable Funds.
Investment is the
Source of the Demand
For Loanable Funds.
A Higher Interest Rate Would
Encourage Saving (Thereby
Increasing the Quantity of
Loanable Funds Supplied) and
Discourage Borrowing For
Investment (Thereby
Decreasing the Quantity of
Loanable Funds Demanded).
Likewise a Lower Interest Rate
Would Discourage Saving
(Thereby Decreasing the
Quantity of Loanable Funds
Supplied) and Encourage
Borrowing For Investment
(Thereby Increasing the
Quantity of Loanable Funds
Demanded).
Market For Loanable Funds
Interest
Rate
Surplus
--------------------------
------------------------
5%
Supply
Shortage
0
$1,200
Demand
Loanable Funds
(In Billions of Dollars)
Problem?
The United States Has a
Lower Saving Rate Than
Many of the Other
Nations In the World.
In 1999 Percentage of GDP
Saved: (Source McConnell)
Country
Saved
India
20%
China
42
Japan
30
Germany
23
United States
15
Note:
Many Very Poor Countries
Such as Chad, Ghana,
Madagascar and Uganda Have
a Negative Savings Rate or in
the 0-6% Range as the People
Are to Poor to Save.
So What If Anything
Should or Can a
Government Do to Affect
the Savings Rate of the
United States.
First :
The Government Can Reform
its Tax Laws to Encourage
Greater Savings, The Result
Would Be Lower Interest
Rates and Greater
Investment.
Policy 1: Savings
Incentives
If the Government Allows a
Person to Shelter Some of
Their Saving From Taxation.
Example: IRA, Bonds.
Tax Incentives
Tax Incentives For Savings Increase
the Supply of Loanable Funds.
2. The Increase in the Supply of
Loanable Funds, Reduces the
Equilibrium Interest Rate.
3. The Increase in the Supply of
Loanable Funds, Raises the
Equilibrium Quantity of Loanable
Funds.
1.
Market For Loanable Funds
Interest
Supply
Rate
S1
4%
------------------------------------
0
-----------------
--------------------------
------------------------
5%
$1,200 $1,600
Supply
S2
Demand
Loanable Funds
(In Billions of Dollars)
Policy 2: Investment
Incentives
Investment Tax Credit
Gives a Tax Advantage to
Any Firm Building a
Factory or Buying a New
Piece of Equipment.
If a Reform of the Tax Laws
Encouraged Greater
Investment, Through a Vehicle
Such as An Investment Tax
Credit, The Result Would Be
Higher Interest Rates and
Greater Savings.
An Investment Tax Credit
1. An Investment Tax Credit
Increases the Demand For Loanable
Funds.
2. An Increased Demand for Loanable
Funds Raises the Equilibrium
Interest Rate
3. An Increased Demand for Loanable
Funds Raises the Equilibrium
Quantity of Loanable Funds.
Market For Loanable Funds
Interest
Rate
Supply
5%
--------------------------
0
--------------------------------
---------------------------------
------------------------
6%
$1,200 $1,400
D2 Demand
D1 Demand
Loanable Funds
(In Billions of Dollars)
Policy 3: Government Budget
Deficits and Surpluses.
Governments Finance Budget
Deficits By Borrowing in the
Bond Market, and the
Accumulation of Past
Government Borrowing is
Called Government Debt.
A Government Budget Deficit
A Budget Deficit Decreases the
Supply of Loanable Funds.
2. The Decrease in Loanable Funds
Raises the Equilibrium Interest
Rate.
3. The Decrease in Loanable Funds
Reduces the Equilibrium
Quantity of Loanable Funds.
1.
Market For Loanable Funds
Interest
S2 Supply
Rate
S1 Supply
5%
--------------------------
0
------------------------
-----------------
-------------------------------
6%
$800
$1,200
D1 Demand
Loanable Funds
(In Billions of Dollars)
Figure 5 The U.S. Government Debt
Percent
of GDP
120
World War II
100
80
60
Revolutionary
War
Civil
War
World War I
40
20
0
1790
1810
1830
1850
1870
1890
1910
1930
1950
1970
1990
2010
Questions
?
Quick Write
If You Were President of
the United States, What
Would You Do About the
Savings Problem In the
U.S.?