Econ 2301 Macroeconomics

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Econ 2301Macroeconomics

• Dr. Jacobson
• Mr. (Coach) Stuckey

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Chapter 10SavingsInvestment Spendingand
theFinancial System
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National Savings
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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 nations income that is not
  consumed.

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Equation for National Savings

• SY-C-G
• SI

GDP YCIG

• SNational Savings, YGDP, CConsumption,
  GGovernment Purchases, IInvestment

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SavingsInvestment

• 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
  nations savings and direct it to the nations
  investment.

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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 nations long-term
  economic growth and future living standards.
• Higher savings and investment contribute to
  increased productivity and stronger economic
  growth.

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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.

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Positivity of National Savings

• Savings is the main source of funds available for
  domestic investment in new capital goods.

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Ways to Higher National Savings

• Tax Reforms
• Budget Deficit
• Social Security

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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.

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Budget Deficit

• Create a plan to reduce the deficit over time
  relative to the size of the economy.
• Restrain government spending growth

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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.

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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.

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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.

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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

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How Many of You Would Like to Either Start Your
Own Business or Take Over a Family Business?
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Lack of Money or Not Enough Money is the Cause of
Most Start-up Businesses Going Broke.
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Many People Have Great Ideas and Even Great
Products That Can Not Make a Go of It.
Why?Usually Implementation!
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Implementation Usually Means Money or Lack
thereof.
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Where Can One Go To Get the Necessary Capital?
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Places to Get Capital

• Money From Friends.
• Mortgage Your House.
• Relatives.
• Sell Assets.
• Banks.
• Venture Capitalists.
• Sell Stock.
• Find Investors.

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In the Last Chapter We Looked at the Various Ways
for a Country to Increase its Production.
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When People Start New Businesses Can Not That
Increase a Nations GDP?
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In this Chapter We are Going to Explore the
Various Methods Nations, Companies and
Individuals Use to Either Raise Capital or Invest.
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In ShortWhat is the Engine Driving Production
With the Needed Capital?
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In the Last Chapter We Saw How Savings and
Investment Are Key Ingredients to Long Term
Economic Growth.
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In an Economy There AreSavers- People Who
Spend Less Then They Earn.Borrowers- People Who
Spend More Than They Earn.
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The Financial System Is the Various Institutions
That Brings Savers and Borrowers Together.
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The Financial System-The Group of Institutions
in The Economy That Help to Match One Persons
Savings With Another Persons Investment.
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How Does the Financial System Work?
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Financial Institutions Can Be Grouped Into Two
Categories1. Financial Markets, and2.
Financial Intermediaries.
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Financial MarketsFinancial Markets Are the
(Financial) Institutions Through Which Savers Can
Directly Provide Funds to Borrows.
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The Two Most Important Financial Markets in the
U.S. Economy Are the Bond Market and the Stock
Market.
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A Bond- Is a Certificate of Indebtedness That
Specifies the Obligations of the Borrower To the
Holder of the Bond.
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In Simplest Terms A Bond Can Be Considered A
Loan. It is Usually Issued by Either a
Corporation or The Government.
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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.
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Bonds Usually Have A Date of Maturity and a Rate
of Interest. However This May Take A Wide
Variety of Forms.
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For ExampleBonds 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.
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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.
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Bonds Are Rated According to Their Credit Risk.
Government Bonds Are Considered Less Risky and
Therefore Usually Pay a Lower Interest.
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Government Bonds-May Be Issued By Federal,
State or Local Governments and May Also Have Any
Interest Paid as Being Tax Exempt.
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Important NoteBonds May Go Into Default,
Wherein the Owner May Get Either a Partial
Payment or Nothing.
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The Second Type of Financial Market is Called the
Stock Market.
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StockRepresents 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.
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The Sale of Stock to Raise Money is Called Equity
Finance.The Sale of a Bond to Raise Money is
Called Debt Finance.
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Shares of StockMay Be Sold Through Either a
Private Offering (Limited).Or a Public Offering
and Traded on One of the Many Exchanges.
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Stock PricesThe Price of A Share of Stock is
Determined By Supply and Demand. It is Influenced
By Expectations, Profits and the Overall Economy.
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Bonds Vs. StocksBonds Usually Are
Paid Interest Plus a Return of the Face Amount of
the Bond.Stock Prices Vary As Does the
Companys Profits And the Market. There is No
Guarantee of A Return of Investment.
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2. Financial IntermediariesThe Second Category
Besides Financial Markets is Called Financial
Intermediaries That Are Financial Institutions
Through Which Savers Can Indirectly Provide Funds
to Borrowers.
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Financial IntermediariesTwo of the Most
Important Financial Intermediaries Are Banks and
Mutual Funds.
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Other Financial Intermediaries

• Savings Banks.
• Savings and Loan.
• Life-Insurance-Companies.
• Pension Funds.
• Money Market Funds.
• Credit Unions.

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BanksBanks 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.
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Banks-Take the Savers Deposits and Pay Them an
Interest and Then Charge the Borrowers A Higher
Interest on Their Loans.
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Banks Also Facilitate Trading By Establishing a
Medium of Exchange By Making Money Available.
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A Mutual FundIs 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.
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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.
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Two Advantages of Mutual Funds Over Common Stock

1. 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.

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Mutual Funds Also Allow a Small Investor to Buy a
Number of Different Stocks That They May
Otherwise Not Be Able to Afford.
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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.
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You Will (I Hope) Remember That GDP (Y)
Consumption (C) Investment (I) Government (G)
Net Export (NX)
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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.
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From Your High School Math Days You Will Remember
That This Can Be Changed To ReadI Y C G
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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, SI Or Savings Equals Investment.
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National Saving The Total Income In the Economy
That Remains After Paying for Consumption and
Government Purchases.
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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.
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NoteThis 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.
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We Can Now Rewrite Our Equation asS (Y T
C) (T G)This Equation Separates National
Savings Into Two PiecesPrivate Savings (Y T
C) andPublic Savings (T G)
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Private SavingY T C The Income That
Households Have Left After Paying for Taxes and
Consumption.
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Public SavingT G The Tax Revenue That The
Government Has Left After Paying For Its Spending.
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Budget SurplusAn Excess of Tax Revenue Over
Government Spending.
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Budget DeficitA Shortfall of Tax Revenue From
Government Spending.
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Please Pay Attention as This May Be Hard to
Grasp.
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Important NoteAlthough in the Accounting
Savings Investment For a Nation, That Does Not
Have to Be True For an Individual.
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ExampleIf 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.
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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.
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In ShortMacroeconomists Are Stealing the Word
Investment From What You and I Use it For and
Changing The Meaning.
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Market for Loanable FundsThe Market in Which
Those Who Want to Save Supply Funds and Those Who
Want to Borrow to Invest Demand Funds.
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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.
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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.
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The Term Loanable Funds Refers to All Income That
People Have Chosen to Save and Lend Out Rather
Than Use for Their Own Consumption.
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In the Market of Loanable Funds There is Only One
Interest Rate, Which Is Both The Return to
Savings and The Cost of Borrowing.
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Market For Loanable Funds
Interest Rate
Supply
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Demand
0 1,200
Loanable Funds (In Billions of Dollars)
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Savings Is the Source Of The Supply of Loanable
Funds.
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Investment is the Source of the Demand For
Loanable Funds.
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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).
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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).
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Market For Loanable Funds
Interest Rate
Supply
Surplus
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Shortage
Demand
0 1,200
Loanable Funds (In Billions of Dollars)
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Problem?The United States Has a Lower Saving
Rate Than Many of the Other Nations In the World.
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In 1999 Percentage of GDP Saved (Source
McConnell)Country SavedIndia
20China 42Japan
30Germany 23United States 15
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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.
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So What If Anything Should or Can a Government Do
to Affect the Savings Rate of the United States.
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First The Government Can Reform its Tax Laws
to Encourage Greater Savings, The Result Would Be
Lower Interest Rates and Greater Investment.
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Policy 1 Savings IncentivesIf the Government
Allows a Person to Shelter Some of Their Saving
From Taxation. Example IRA, Bonds.
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Tax Incentives

1. 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.

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Market For Loanable Funds
Interest Rate
Supply S1
Supply S2
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4
------------------------------------
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Demand
0 1,200
1,600
Loanable Funds (In Billions of Dollars)
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Policy 2 Investment IncentivesInvestment Tax
Credit Gives a Tax Advantage to Any Firm Building
a Factory or Buying a New Piece of Equipment.
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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.
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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.

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Market For Loanable Funds
Interest Rate
Supply
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---------------------------------
5
--------------------------
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D2 Demand
D1 Demand
0 1,200
1,400
Loanable Funds (In Billions of Dollars)
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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.
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A Government Budget Deficit

• 1. A Budget Deficit Decreases the Supply of
  Loanable Funds.
• The Decrease in Loanable Funds Raises the
  Equilibrium Interest Rate.
• The Decrease in Loanable Funds Reduces the
  Equilibrium Quantity of Loanable Funds.

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Market For Loanable Funds
Interest Rate
S2 Supply
S1 Supply
6
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5
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D1 Demand
0 1,200
800
Loanable Funds (In Billions of Dollars)
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Figure 5 The U.S. Government Debt
Percent
of GDP
120
100
80
60
40
20
0
1790
1810
1830
1850
1870
1890
1910
1930
1950
1970
1990
2010
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Questions?
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Quick WriteIf You Were President of the United
States, What Would You Do About the Savings
Problem In the U.S.?