Chapter 7
Savings and Investment
Process
© 2011 John Wiley and Sons
Chapter Outcomes



Identify and briefly describe the
major components of the gross
domestic product
Describe how the balance between
exports and imports affects the
gross domestic product
Describe recent developments in the
aggregate level of personal and
corporate savings
2
Chapter Outcomes
(Continued)



Describe the principal sources of
federal government revenues and
expenditures
Discuss the historical role of savings
in the United States and how savings
are created
Identify the major sources of savings
in the United States
3
Chapter Outcomes
(Concluded)



Identify and describe the factors that
affect savings
Describe the major capital market
securities that facilitate the savings
and investment process
Discuss the role of individuals in the
recent financial crisis
4
Gross Domestic Product (GDP)
and Capital Formation


Gross Domestic Product:
Measures the output of goods and
services in an economy over a
specified time period
Capital Formation:
Process of constructing real
property, manufacturing producers’
durable equipment, and increasing
business inventories
5
Gross Domestic Product (GDP)
Components
GDP is composed of:
 Personal Consumption Expenditures
 Government Expenditures including
Gross Investment
 Gross Private Domestic Investment
 Net Exports of Goods and Services
6
Gross Domestic Product (GDP)
Components (continued)


Equation:
GDP = PCE + GE + GPDI + NE
Personal Consumption Expenditures
(PCE):
Expenditures by individuals for durable
goods, nondurable goods, and services

Government Expenditures (GE):
Purchases of goods and services by the
government
7
Gross Domestic Product (GDP)
Components (continued)


Equation:
GDP = PCE + GE + GPDI + NE
Gross Private Domestic Investments
(GPDI):
Investments in residential & nonresidential
structures, producers’ durable equipment,
& business inventories

Net Exports (NE):
Exports minus imports of goods & services
8
Recent Gross Domestic Product
(GDP) Amounts





($ Billions)
GDP
PCE
GPDI
NE
GE
2006
2009
$13,253.9 $14,258.7
9,270.8 10,092.6
2,218.4
1,622.9
-761.8
-390.1
2,526.4 2,933.3
9
Link Between Saving and
Investment


Gross Saving = Net Saving +
Consumption of Fixed Capital
For 2008 (in $ Billions):
Net Saving =
-$23.0
Consumption of Fixed Capital = $1,847.1
Gross Saving =
$1,824.1
10
Link Between Saving and
Investment


Net Saving = Net Private Saving + Net
Government Saving
For 2008 (in $ Billions):
Net Private Saving =
$659.8
Net Government Saving =
-$682.7
Net Saving (rounded) =
-$23.0
11
Link Between Saving and
Investment


Consumption of Fixed Capital = Private +
Government
For 2008 (in $ Billions):
Private =
$1,536.2
Government =
$310.9
Consumption of Fixed Capital = $1,847.1
12
Federal Government Receipts and
Expenditures

1970-1997:
Annual deficit budgets

1998-2001:
Annual surplus budgets

2002-Present:
Annual deficits with fiscal 2009 and 2010
deficits each exceeding $1.0 trillion
[National Debt now exceeds $12 trillion]
13
Federal Government Dollar:
Fiscal Year 2008

Where It Comes From (Income):
--Personal Income Taxes (39%)
--Social Security and other Retirement
Taxes (30%)
--Borrowing to Cover Deficit (15%)
--Corporate Income Taxes (10%)
--Excise, Estate, and other Taxes (6%)
14
Federal Government Dollar:
Fiscal Year 2008 (continued)

Where It Goes (Outlays):
--Social Security, Medicare, and other
retirement (37%)
--National Defense, veterans, and Foreign
Affairs (24%)
--Social Programs (including Medicaid)(20%)
--Physical , Human, and Community
Development (9%)
--Net Interest on the Debt (8%)
--Law Enforcement and General Gov’t. (2%)
15
Debt Financing


Budgetary Deficit:
Occurs when expenditures are
greater than revenues
Federal Statutory Debt Limits:
Limits on the federal debt set by
Congress
16
Historical Role of Savings in the
United States


Foreign investors initially purchased
large amounts of the securities sold
by government & private promoters
to develop the U.S.
The American family later took over
the function of providing savings for
the capital formation process
17
Creation of Savings


Savings:
Income that is not consumed but
held in the form of cash and other
financial assets
Savings Surplus:
Occurs when current income
exceeds investment in real assets
18
Creation of Savings


Savings Deficit:
Occurs when investment in real
assets exceeds current income
Undistributed Profits:
Proportion of after-tax profits
retained by corporations
19
Major Sources of Savings

Personal Saving:
Savings of individuals equal to personal
income less personal current taxes less
personal outlays

Voluntary Savings:
Savings held or set aside by choice for
future use

Contractual Savings:
Savings accumulated on a regular
schedule by prior agreement
20
Personal Savings in the U.S.


Personal Savings Definition:
Personal income
Less: taxes and other payments
Equals: disposable personal income
Less: personal outlays
Equals: personal savings
Savings Rate Definition:
Savings Rate = (Personal Savings)/
(Disposable Personal Income)
21
Historical Personal Savings Rates










1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
5.8%
7.0
8.1
9.2
7.1
4.5
4.3
4.8
1.0
1.4
22
Corporate Savings in the U.S.


Undistributed Profits Definition:
Profits before taxes
Less: tax liabilities
Equals: profits after taxes
Less: dividends
Equals: undistributed profits
Retention Rate Definition:
Retention Rate = (Undistributed
Profits)/(Profits After Taxes)
23
Corporate Savings in the U.S.

Adjustments to Corporate Profits:

Nonfinancial corporate profits before
taxes are often shown after (1) inventory
valuation and (2) capital consumption
adjustments
(1) Records estimated changes in
inventory values over time
(2) Reflects the “using up,” or
depreciation, of plant and equipment
assets used for business purposes

24
Factors Affecting Savings




Levels of income
Economic expectations
Cyclical Influences (economic
cycles)
Life stage of the individual saver
or corporation
25
Life Stages of the Individual Saver

Individual Saver:
--Formative/education developing
--Career starting/family creating
--Wealth building
--Retirement enjoying
26
Life Stages of the Corporation

Corporation:
--Start-up stage
--Survival stage
--Rapid growth stage
--Maturity stage
27
Capital Market Securities


Capital Markets:
Markets where debt securities with
maturities longer than one year and
corporate stocks are issued or
traded
Capital Market Securities:
Debt securities with maturities longer
than one year and corporate stocks
28
Major Capital Market Securities





Securities:
Mortgages
Treasury bonds
Municipal bonds
Corporate bonds
Corporate stocks
Issuers:
Fin. intermediaries
U.S. government
State/local gov’ts.
Corporations
Corporations
29
Major Capital Market Securities





Securities:
Mortgages
Treasury bonds
Municipal bonds
Corporate bonds
Corporate stocks
Secondary Market:
High activity
High activity
Moderate activity
Moderate activity
High activity
30
Capital Market Securities Defined

Mortgage:
Loan backed by real property in the form
of buildings and houses

Treasury bond:
Long-term debt instrument issued by the
U.S. federal government

Municipal bond:
Long-term debt instrument issued by a
state or local government
31
Capital Market Securities Defined

Corporate bond:
Debt instrument issued by a corporation
to raise long-term funds

Common stock:
Ownership interest in a corporation
32
Derivative Security


Derivative Security:
Financial contract that derives its
value from a bond, stock, or other
asset
Use of Derivative Securities:
Corporations can use derivative
securities to insure or hedge against
various financial risks
33
2007-09 Financial Crisis
Early Factors:



2000 -- Internet or “tech” bubble burst and
stock prices began declining rapidly
2001 -- Economic recession resulted
(exacerbated by the 9/11/2001 terrorist
attacks)
2001-2002 – Monetary policy focused on
providing liquidity and fiscal policy
became stimulative resulting in low
interest rates and economic growth
34
2007-09 Financial Crisis
Borrowing-Related Cultural Shift:



U.S. consumers moved from “save now,
buy later” to “spend now, pay later” with
the result being increased mortgage loans
and credit card borrowings
U.S. government officials encouraged
wider home ownership and mortgage
lenders offered adjustable-rate mortgages
(ARMs) and even subprime mortgages to
poorly qualified borrowers
The “housing price bubble” burst in mid2006 and home owners began defaulting 35
Web Links




www.bea.gov
www.irs.gov
www.stlouisfed.org
www.federalreserve.gov
36