ch 13: savings, investment, and the financial system

savings:

a vehicle for transferring purchase power to the future

investment:

purchases of new capital (such as equipment or building), borrowing to finance those purchases

what is national income account identity used for?

used to determine how important macroeconomic indicators are related to each other

national income account identity equation:

Y= C+I+G+NX

an identity is an equation that _______________________ because of the way the variables in the equation are defined

must be true

why is the identity in an equation useful?

because they clarify how different variables are related to each other

open economy:

trade

Y=C+I+G+NX

closed economy:

no trade

Y=C+I+G

nation saving equation:

S=I, equal to investment in a closed economy!

what is private saving and its equation?

leftover income households have after spending for C and paying T

Y-C-T

what is public saving and its equation?

leftover tax revenue that the government has after paying for all of its spending

T-G

what is tax (T)?

the amount that the government collects from households in taxes minus the amount that the government pays for transfer payments

what is the government budget?

how much money they are allowed to spend on purchasing in a given year

what is the government’s budget balance determined by?

whether they spend more or less than they take in that year

the government’s “income” is ________________

tax revenue

when the government spends more than they collect in tax revenue, they run a _______________, where public saving: T-G __ 0 → T<G

budget deficit, <

when the government spends less than they collect in tax revenue, they run a _____________, where public saving: T-G __ 0 → G<T

budget surplus, >

what is money illusion? when people see rising prices, they feel that they are ___________ off

worse

what is nominal interest rate?

the rate of growth in the dollar value of a deposit or debt

what is real interest rate?

it is corrected for inflation and is the rate of growth in the purchasing power of a deposit or debt

what is teh fisher equation

real interest rate (R) = nominal interest rate (N) - inflation rate (π)

for the economy as a whole in a closed economy: savings = ____________

investment

what is the purpose of matching savings and investment?

to explain how financial markets coordinate the economy’s savings and investments

what does this help us to understand? how government policies and other factors affect _________________________

savings, investments, and interest rate

what is a loanable fund?

income that people have chosen to save and lend out, rather than use for their own consumption, and to the amount that investors have chosen to borrow to fund newinvestment projects

loanable fund can also be thought of as the ________ of resources available to fund ______________________

flow, private investment

where does the supply of loanable funds come from?

it comes from people who save extra income they want to save and lend out

saving is the ___________ of the supply of loanable funds

source

households with extra income can ________________ and earn interest

lend it out

where does the demand for loanable funds come from?

it comes from households and firms who wish to borrow to make investments to purchase capital goods

invetment is the ____________ of the demand for loanable funds

source

firms borrow the funds they need to pay for ________________ factories, etc.

new equipment

households borrow the funds they need to _______________ new homes

purchase

in equilibrium: supply = demand saving = ___________-

investment

demand for loanable funds is still governed by the _______________

law of demand

price = real interest rate: what you _____________ to borrow the money

have to pay

as the real interest rate increases, the __________________ of loanable fudns demanded decreases

quantity

borrowing becomes more ____________ so you demand fewer loans/dollars

expensive

supply for loanable funds is still governed by the _____________

law of supply

price = real interest rate: what you ____________ for letting other people borrow your money

earn

as the real interest rate increases, the quantity of loanable funds supplied _____________

increases

savings becomes more profitable so you ____________ more dollars

save

how to determine changes in saving and investment behavior

policy shifts the supply or demand curve, determines the direction of the shift, and seeing how the equilibrium

a policy choice is saving incentives, what is it?

saving incentives are designed to encourage people to save more

saving incentives reduces taxes from interest incomes, so therefore tax _________ reduces → ____________ people to save more → _________ increases

burden, encourages, savings

saving incentives decreases risk/financial safety nets, for certain types of savings, ____________ the risk or providing a financial “backstop” could __________ savings

decreasing, increase

federal deposit insurance corporation guarantees a certain amount of a person’s savings even if the ____________________

bank fails

what are the steps in saving incentives?

change in tax encouraging americans to save more, supply increases, and interest rate would fall, stimulating investment, quality of life increases. (a→b)

the goal of saving incentive sis to _______________ national savings

increase

when a savings incentive is introduced, the supply curve of loanable funds shifts to the ___________, there is a _________ equilibrium quantity of loanable funds, and there is a ___________ equilibrium real interest rate

right, high, lower

what is the policy choice of an investment incentive?

it attempts to increase the amount people are willing to borrow at very interest rate

what are investment tax credits

a reduction in taxable income that is awarded to people/firms that invests in certain manners

what are the steps for investment incentives

demand moves, demand increases, interest rate increases, quality of life increases

what is the goal of investment incentives is to

increase investment which is good for living standards

when an investment incentive is introduced, the demand curve for loanable funds shifts to the __________, there is a ____________ equilibrium quantity of loanable funds, and a ___________ equilibrium of real interest rate

right, higher, higher

for policy choices, do we save or invest?

both can increase our living standards

but does it matter which policy we choose? yes! saving incentives __________ interest rate while investment incentives ____________ interest rate

decreases, increase

for policy choices, what does it mean for government budgeting deficits and surpluses?

the government can actively set policies to influence the amount of savings and investment in the economy

they can also influence the market for loanable funds directly based on their own ___________ behavior

savings

recall that national savings = ___________ savings + public savings (Y-C-T) + (T-G). this means that when the government runs a budget surplus or deficit, they ___________ the amount of national savings that is available in the loanable funds market

private, change

imagine that the government starts running a budget deficit, the government finance budget deficits by _____________ in the bond market (issued by US government)

borrowing

the accumulation of past government borrowing is called the _______________________

government debt

what is the crowding out effect

government must borrow to cover their budget deficit

it crowds out private investment (household/firm) by ___________________________________ to borrow because interest rate increases leading to investment _____________

making it harder and more expensive, decreases

budget deficit _____________ reduces the economy’s growth rate and future standard of living

reduces

what are the steps for budget deficit?

budget deficit lowers saving, supply decreases moves to the left, interest rate increases, loanable funds decreases

when the government runs a budget deficit: supply curve for loanable funds shifts to the __________, there is a ________________ equilibrium quantity of loanable funds, and a ___________ equilibrium real interest rate

left, lower, higher