Saving, Investment, and the Financial System

Key vocabulary and macroeconomic concepts related to the financial system, national saving identities, and the market for loanable funds.

Financial System

The group of institutions that help match one person’s saving with another person’s investment, channeling resources from savers to borrowers.

Direct Finance

A method of funding where savers directly provide funds to borrowers through financial markets, such as the bond or stock markets.

Bond

A certificate of indebtedness that specifies the obligations of the borrower to the holder of the bond.

Term

The length of time until a bond matures.

Credit Risk

The probability that a borrower will fail to pay some of the interest or principal on a bond (probability of default).

Stock

A claim to partial ownership in a firm and its future profits.

Equity Finance

The process of raising money by selling stock in a company.

Debt Finance

The process of raising money by selling bonds.

Stock Index

A value computed as an average of a group of stock prices used to monitor the overall level of stock prices.

Financial Intermediaries

Institutions through which savers can indirectly provide funds to borrowers, such as banks and mutual funds.

Medium of Exchange

An item that people can easily use to purchase goods and services, such as checking accounts or debit cards provided by banks.

Mutual Funds

Institutions that sell shares to the public and use the proceeds to buy a portfolio of stocks and bonds.

Diversification

A practice that allows small savers to spread risk by owning pieces of many different companies.

Index Funds

Mutual funds that buy all stocks in a specific index and typically outperform managed funds by keeping costs and fees low.

National Saving ($S$)

The total income in the economy that remains after paying for consumption and government purchases, expressed as $S = Y - C - G$.

Private Saving ($S_p$)

The income households have left after paying for taxes and consumption, expressed as $S_p = Y - T - C$.

Public Saving ($S_g$)

The tax revenue the government has left after paying for its spending, expressed as $S_g = T - G$.

Budget Surplus

An excess of tax revenue over government spending, occurring when $T > G$.

Budget Deficit

A shortfall of tax revenue from government spending, occurring when $T < G$.

Market for Loanable Funds

The market in which those who want to save supply funds and those who want to borrow to invest demand funds.

Crowding Out

The fall in investment that results from government borrowing, which reduces national saving and shifts the supply of loanable funds to the left.