CHAPTER 26 Savings, Investment Spending, and the Financial System PowerPoint® Slides by Can Erbil © 2005 Worth Publishers, all rights reserved What you will learn in this chapter: The relationship between savings and investment spending About the loanable funds market, which shows how savers are matched with borrowers The purpose of the four principal types of assets: stocks, bonds, loans, and bank deposits How financial intermediaries help investors achieve diversification Some competing views of what determines stock prices and why stock market fluctuations can be a source of macroeconomic instability 2 The Savings–Investment Spending Identity in a Closed Economy In a closed economy: GDP = C + I + G SPrivate = GDP + TR − T − C SGovernment = T − TR − G NS = SPrivate + SGovernment = (GDP + TR − T − C) + (T − TR − G) = GDP − C − G Hence, I = NS Investment spending = National savings in a closed economy 3 Budget Surplus and Budget Deficit 4 The Savings–Investment Spending Identity in an Open Economy I = SPrivate + SGovernment + (IM – X) = NS + KI (10) Investment spending = National savings + Capital inflow in an open economy 5 The Savings-Investment Spending Identity in Open Economies: the United States and Japan 2003 6 The Demand for Loanable Funds 7 The Supply for Loanable Funds 8 Equilibrium in the Loanable Funds Market 9 Savings, Investment Spending, and Government Policy 10 Increasing Private Savings 11 The Financial System - Definitions Wealth Current Savings + Accumulated Savings Financial asset Paper claim that entitles the buyer to a future claim from the seller. Physical asset Claim on a tangible object (home, car, etc.) Liability A requirement to pay income in the future (Car loan, mortgage, etc.) Transaction costs Expenses of putting together and executing a deal Financial risk Uncertainty about future outcomes that involve financial loses and gains. 12 Risk-Averse Attitudes Toward Gain and Loss 13 Three Tasks of a Financial System Reducing transaction costs Reducing financial risk Providing liquid assets Liquid assets can be quickly converted into cash, while illiquid assets cannot. 14 Types of Financial Assets Loans Bank Deposits Stocks A share of ownership in a company Bonds A promise by the seller to pay interest each year and to repay the principal to the owner of the bond on a particular date. 15 Financial Intermediaries Mutual funds Pension funds Life insurance companies Banks 16 Financial Fluctuations Financial market fluctuations can be a source of macroeconomic instability. Are markets irrational? Policy makers assume neither that markets always behave rationally nor that they can outsmart them. 17 The End of Chapter 9 coming attraction: Chapter 10: Aggregate Supply and Aggregate Demand 18