Savings, Investment & The Financial System

“Investment” In Economics

A company borrowing money to produce something (not an individual buying shares of a company). 

“Total Income”

“Total Spending”

GDP (In this chapter)

C + I + G [Closed Economy]

What can income be spent on?

Private Consumption (C), Government Purchases (G) or Saved (S). That saved money can be spent for Investment (I).

Budget Surplus

Earn > Spend (S > 0)

Budget Deficit

Earn < Spend (S < 0)

National Savings

Gov. + Private Savings

Net Capital Inflow

The total inflow of funds into a country minus the total outflow of funds out of the country.

NCI = IM-X

Represents funds borrowed from foreigners.

Total Savings

Government Savings + Private Savings + “Net Capital Inflow”

Loanable Funds Market

• Demanders: firms with investment spending projects

• Suppliers: savers

• Quantity: $ of loanable funds •

Price: r or the nominal interest rate

Demand For Loanable Funds 

Interest Rate Measures Opportunity Cost of Investment Spending. Only worth it to demand funds that you think future return > cost.

Why is Equilibrium important for a well-functioning market?

• Right investments get made: projects with higher payoffs get financed.

• Right people do the saving and lending: those who are willing to lend for lower interest rates get to save and lend.

Shifting Demand & Supply (Demand/Borrowers)

• Changes in perceived business opportunities.

• Changes in Gov. Borrowing. 

Shifting Demand & Supply (Supply/Lenders)

• Changes in private savings balance.

• Changes in net capital inflows.

Changes in the interest rate (R)

DO NOT CAUSE SHIFTS IN SUPPLY AND DEMAND, and are just movements along the curve.

Fisher Effect

Increase in future inflation drives up nominal price rate, leaving the expected real interest rate unchanged.