Transcript Saving, Investment, and the financial system

PowerPoint Presentations for
Principles of Macroeconomics
Sixth Canadian Edition
by Mankiw/Kneebone/McKenzie
Adapted for the
Sixth Canadian Edition by
Marc Prud’homme
University of Ottawa
SAVING,
INVESTMENT, AND
THE FINANCIAL
SYSTEM
Chapter 8
SAVING, INVESTMENT, AND
THE FINANCIAL SYSTEM
 Financial system: the group of institutions in the
economy that help to match one person’s
savings with another person’s investment
 This chapter examines how the financial system
works.
FINANCIAL INSTITUTIONS
IN THE CANADIAN ECONOMY
Financial institutions can be grouped into
two categories:
Financial markets
Financial intermediaries
Financial Markets
Financial markets: financial institutions
through which savers can directly provide
funds to borrowers
There is a direct relationship between borrowers
and lenders
Financial Markets: The Bond Market
Bond: a certificate of indebtedness that specifies
the obligation of the borrower to the holder of
the bond
Someone borrows some $$$$ (money)
Debt finance: the sale of a bond to raise
money
Characteristics:
bond’s term
bond’s credit risk
If Buying a Bond  lending money
If Selling a Bond  borrowing money
Bond is really small chunks of a loan
Ex: $1M loan = 10 000 of $100 bonds
Financial Markets: The Stock Market
 Stock: represents ownership
in a firm and is, therefore, a
claim to its profits
 The prices at which shares
trade on stock exchanges
are determined by the
supply and demand for the
stock.
moodboard/Thinkstock
 Equity finance: the sale of a
stock to raise money
Financial Markets: The Stock Market
 Stock index: is an average of a group of stock
prices
 Dow Jones Industrial Average
 S&P/TSX Composite Index
 Because stock prices reflect expected
profitability, stock indexes are watched closely
as possible indicators of future economic
conditions.
Financial Intermediaries
Financial intermediaries: financial
institutions through which savers can
indirectly provide funds to borrowers
Ex: Banks & Mutual Funds
Financial Intermediaries
Thinkstock
Bank: The primary
function of a bank is
to take deposits from
savers and use these
deposits to make
loans to people who
want to borrow.
Financial Intermediaries
Mutual funds: an institution that sells shares
to the public and uses the proceeds to
buy a portfolio of stocks and bonds
Allow diversification
Access to the skills of professional
money managers
SAVING AND INVESTMENT
IN THE NATIONAL ACCOUNTS
Accounting: refers to how various
numbers are defined and added up
The national income accounts include, in
particular, GDP and many related
statistics.
Some Important Identities
In a closed economy:
Some Important Identities
National saving (S): the total income in the
economy that remains after paying for
consumption and government purchases
Some Important Identities
Let T denote the taxes collected by
government minus transfer payments.
National saving can then be expressed in
either of two ways:
or
Some Important Identities
Private saving: the income that households
have left after paying for taxes and
consumption
Public saving: the tax revenue that the
government has left after paying for its
spending
Some Important Identities
Budget surplus:
Budget deficit:
T=Taxes
G=Government Spending
The Meaning of Saving and Investment
The terms saving and investment can
sometimes be confusing.
Although the accounting identity S = I
shows that saving and investment are
equal for the economy as a whole, this
does not have to be true for every
individual household or firm.
QuickQuiz
Define the following:
• Private saving
• Public saving
• National saving
• National investment
How are they related?
Active Learning
A. Calculations
 Suppose GDP equals $10 million, consumption
equals $6.5 million, the government spends $2
million and has a budget deficit of $300 million.
 Find public saving, taxes, private saving,
national saving, and investment.
Active Learning
Answers: Part A
Given:
Y (is GDP) = 10.0, C = 6.5, G = 2.0, G – T = 0.3
Public saving = T – G = – 0.3
Taxes: T = G – 0.3 = 1.7
Private saving = Y – T – C = 10 – 1.7 – 6.5 = 1.8
National saving = Y – C – G = 10 – 6.5 = 2 = 1.5
Investment = national saving = 1.5
Active Learning
B. Calculations
 Use the numbers from the preceding exercise but
suppose now that the government cuts taxes
by $200 million.
 In each of the following two scenarios, determine
what happens to public saving, private saving,
national saving, and investment.
1. Consumers save the full proceeds of the tax
cut.
2. Consumers save 1/4 of the tax cut and spend
the other 3/4.
Active Learning
Answers: Part B
In both scenarios, public saving falls by $200
million, and the budget deficit rises from $300
million to $500 million.
1. If consumers save the full $200 million,
national saving is unchanged, so investment
is unchanged.
2. If consumers save $50 million and spend
$150 million, then national saving and
investment each fall by $150 million.
Active Learning
C. Discussion Questions
The two scenarios from this exercise were:
1. Consumers save the full proceeds of the
tax cut.
2. Consumers save 1/4 of the tax cut and
spend the other 3/4.
 Which of these two scenarios do you think is
more realistic?
 Why is this question important?
THE MARKET FOR LOANABLE FUNDS
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
Supply and Demand for Loanable Funds
Saving is the source of supply for loanable
funds.
Investment is the source of demand for
loanable funds.
The interest rate is the price of a loan.
FIGURE 8.1:
The Market for Loanable Funds
Policy I: Saving Incentives
A higher saving rate could lead to a
higher rate of growth of GDP.
People respond to incentives:
Consumption taxes like the GST
RRSPs
TFSA
RESP
FIGURE 8.2:
An Increase in the Supply of Loanable Funds
Policy 2: Investment Incentives
An investment tax credit gives a tax
advantage to any firm building a new
factory or buying a new piece of
equipment.
FIGURE 8.3:
An Increase in the Demand for Loanable Funds
Policy 3: Government Budget
Deficits and Surpluses
Government debt: the sum of past budget
deficits and surpluses
FIGURE 8.4:
The Effect of a Government Budget Deficit
Policy 3: Government Budget
Deficits and Surpluses
Crowding out: a decrease in investment
that results from government borrowing
FIGURE 8.5:
Federal and Provincial/Territorial Net Debt in Canada
QuickQuiz
If more Canadians adopted a “live for
today” approach to life, how would
this affect saving, investment, and the
interest rate?
Classroom Activity
Create a Portfolio
Assume you have $100 000 in savings. Create a portfolio
of securities worth $100 000. Decide what financial
instruments you would like to use, then find their
current prices in the newspaper.
1. Calculate your holdings of each security, based on
current prices.
2. What objectives do you have for this portfolio? Was it
chosen to maximize short-term gains, long-term
stability, or some other objective?
Classroom Activity
Create a Portfolio
3. Explain how each of the following economic events
would affect the value of your portfolio.
A. an increase or decrease in interest rates
B. a recession
C. rapid inflation
D. a depreciation of the Canadian dollar
THE END
Chapter 8