1、26Saving, Investment, and the Financial SystemThe Financial System The financial system 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 to borrowers.FINANCIAL INSTITUTIONS IN

2、 THE U.S. ECONOMYThe 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 intermediaries.FINANCIAL INSTITUTIONS IN THE U.S. ECONOMYFinancial Marke

3、tsStock MarketBond MarketFinancial IntermediariesBanksMutual FundsFINANCIAL INSTITUTIONS IN THE U.S. ECONOMYFinancial markets are the institutions through which savers can directly provide funds to borrowers.Financial intermediaries are financial institutions through which savers can indirectly prov

4、ide funds to borrowers.Financial MarketsThe Bond MarketA bond is a certificate of indebtedness thatspecifies obligations of the borrower to the holder of the bond.Characteristics of a BondTerm: The length of time until the bond matures.Credit Risk: The probability that the borrower will fail to pay

5、some of the interest or principal.Tax Treatment: The way in which the tax laws treat the interest on the bond.Municipal bonds are federal tax exempt.IOUFinancial Markets The Stock MarketStock represents a claim to partial ownership in a firm and is therefore, a claim to the profits that the firm mak

6、es.The sale of stock to raise money is called equity financing.Compared to bonds, stocks offer both higher 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.Financial Markets The Stock

7、MarketMost newspaper stock tables provide the following information:Price (of a share)Volume (number of shares sold)Dividend (profits paid to stockholders)Price-earnings ratioFinancial IntermediariesFinancial intermediaries are financial institutions through which savers can indirectly provide funds

8、 to borrowers.Financial IntermediariesBankstake 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.Financial Intermediaries BanksBanks help create

9、 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.Financial IntermediariesMutual FundsA mutual fund is an institution that sells sh

10、ares 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.Financial Intermediaries Other Financial Institutions Credit unionsPension fundsInsurance companiesLoan sharksSAVING AND INVESTMEN

11、T IN THE NATIONAL INCOME ACCOUNTSRecall that GDP is both total income in an economy and total expenditure on the economys output of goods and services:Y = C + I + G + NXSome Important IdentitiesAssume a closed economy one that does not engage in international trade:Y = C + I + GSome Important Identi

12、tiesNow, subtract C and G from both sides of the equation:Y C G =IThe left side of the equation is the total income in the economy after paying for consumption and government purchases and is called national saving, or just saving (S).Some Important IdentitiesSubstituting S for Y - C - G, the equati

13、on can be written as:S = ISome Important IdentitiesNational saving, or saving, is equal to:S = IS = Y C G S = (Y T C) + (T G)The Meaning of Saving and InvestmentNational SavingNational saving is the total income in the economy that remains after paying for consumption and government purchases.Privat

14、e SavingPrivate saving is the amount of income that households have left after paying their taxes and paying for their consumption.Private saving = (Y T C) The Meaning of Saving and InvestmentPublic SavingPublic saving is the amount of tax revenue that the government has left after paying for its sp

15、ending.Public saving = (T G)The Meaning of Saving and InvestmentSurplus and DeficitIf T G, the government runs a budget 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 i

16、t receives in tax revenue.The Meaning of Saving and InvestmentFor the economy as a whole, saving must be equal to investment. S = ITHE MARKET FOR LOANABLE FUNDSFinancial markets coordinate the economys saving and investment in the market for loanable funds. THE MARKET FOR LOANABLE FUNDSThe market fo

17、r loanable funds is 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 FUNDSLoanable funds refers to all income that people have chosen to save and lend out, rather than use for their own consumption.Supply and Demand f

18、or Loanable FundsThe 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.Supply and Demand for Loanable FundsThe interest rate is the price of the loan.It

19、 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.Supply and Demand for Loanable FundsFinancial markets work much like other markets in the economy.The equilibrium of th

20、e 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-WesternSupply and Demand for Loanable FundsGovernment Policies That Affect Saving and InvestmentTa

21、xes and savingTaxes and investmentGovernment budget deficitsPolicy 1: Saving IncentivesTaxes on interest income substantially reduce the future payoff from current saving and, as a result, reduce the incentive to save.Policy 1: Saving IncentivesA tax decrease increases the incentive for households t

22、o 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 loanable funds increases.Figure 2 An Increase in the Supply of Loanable FundsLoanable Funds(in billions of dollars)0InterestRateSupply, S1S22. .

23、 . . whichreduces theequilibriuminterest rate . . .3. . . . and raises the equilibriumquantity of loanable funds.Demand1. Tax incentives forsaving increase thesupply of loanablefunds . . .5%$1,2004%$1,600Copyright2004 South-WesternPolicy 1: Saving IncentivesIf a change in tax law encourages greater

24、saving, the result will be lower interest rates and greater investment.Policy 2: Investment IncentivesAn 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

25、.Policy 2: Investment IncentivesIf a change in tax laws encourages greater 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

26、 loanable funds . . .2. . . . whichraises theequilibriuminterest rate . . .3. . . . and raises the equilibriumquantity of loanable funds.SupplyDemand, D1 D25%$1,2006%$1,400Copyright2004 South-WesternPolicy 3: Government Budget Deficits and SurplusesWhen the government spends more than it receives in

27、 tax revenues, the short fall is called the budget deficit.The accumulation of past budget deficits is called the government debt.Policy 3: Government Budget Deficits and SurplusesGovernment borrowing to finance its budget deficit reduces the supply of loanable funds available to finance investment

28、by households 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.Policy 3: Government Budget Deficits and SurplusesA budget deficit decreases the supply of loanable funds. Shifts the supply curve

29、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. . . . whichraises theequil

30、ibriuminterest rate . . .Supply, S1Demand$1,2005%$8006%1. A budget deficitdecreases thesupply of loanablefunds . . .Copyright2004 South-WesternPolicy 3: Government Budget Deficits and SurplusesWhen government reduces national saving by running a deficit, the interest rate rises and investment falls.

31、Policy 3: Government Budget Deficits and SurplusesA budget surplus increases the supply of loanable funds, reduces the interest rate, and stimulates investment.Figure 5 The U.S. Government DebtPercentof GDP17901810183018501870189019101930195019701990RevolutionaryWar2010CivilWarWorld War IWorld War II020406080100120Copyright2004 South-WesternSummaryThe U.S. financial system is made up of financial institutions such as the bond market,