Chapter 9 Macro

Invester Confidence

-a measure of what firms expect for future economic activity -if confidence is high, they are more likely to borrow for investment at any interest rate

Interest Rate

-a price of loanable funds

Misconception: the government sets interest rates

-almost all interest rates in the U.S. economy are determined privately--on the basis of the interaction between the market forces of supply and demand

The Timeline of Production

-at the end of the timeline is output, or GDP -when this output is sold, it produces revenue for the firms, and this revenue serves to pay bills

Increase in Foreign Savings

-U.S. financial markets have offered relatively greater returns than markets in other countries -U.S. financial markets are also considered less risky because of the size and relative robustness of the U.S economy

Changes in Capital Productivity

-changes in capital productivity shift the demand for loanable funds -if capital is more productive, the demand for loans increases; if the capital is less productive, the demand for loans decreases

Productivity of Capital

-demand for loanable funds can increase as a direct result of the availability of a new machine -firms borrow in order to finance capital purchases -the level of demand for loans depends on the productivity of capital

Investment requires saving because

-every dollar borrowed requires a dollar saved

Financial Markets

-financial markets are where firms and governments obtain funds, or financing, for their operations -these funds come primarily from household savings across the economy

Interest Rate for Borrowers

-for borrowers, the interest rate is the costive borrowing -profit-maximizing firms borrow to fund an investment if an only if the expected return on the investment is greater than the interest rate on the loan -the lower the interest rate, the more likely a business will succeed in earning enough to exceed the interest they will owe at the end of the year -there is a larger quantity of loans demanded as the interest rate drops

Real Rate of Interest

-higher inflation rates lead to higher nominal interest rates in order to compensate lenders -nominal interest rate = real interest rate + inflation rate

Investor Confidence Shift in Demand for Loanable Funds

-if capital productivity increases, demand for investment increases from D1 to D2--that is, demand is higher across all interest rates -similarly, if investor confidence increases, demand for loanable funds increases from D1 to D2 -if capital productivity or investor confidence falls, the demand for loanable funds falls from D1 to D3

Income levels during a lifetime

-income levels are low early in life, income rises in midlife ("prime earning years"), and decreases near retirement

Income and Wealth

-increases in income also produce increases in savings; if income declines, people save less -these changes shift the loanable funds supply curve

Interest Rate for Savers

-interest rate is a reward for savers -the higher the interest rate, the greater is the incentive to save -this is the loanable funds version of the law of supply: the quantity of savings rises when the interest rate rises -the positive relationship between interest rates is reflected in the slope of the supply curve (S)

Savings Rate

-is personal saving as a portion of disposable (after-tax) income

Nominal Interest Rate

-is the interest rate before it is corrected for inflation; it is the stated interest rate

Why we use Nominal Interest Rate

-it is the stated interest rate -low and steady inflation means that the difference between real and nominal interest rates doesn't fluctuate much

Equilibrium

-occurs at the interest rate where the plans of savers match the plans of borrowers -where quantity supply equals quantity demanded (ex. at 5% interest rate) -at interest rates above 5% the quantity of loanable funds supplied exceeds the quantity demanded, and this imbalance leads to downward pressure on the interest rate

Consumption Smoothing

-occurs when people borrow and save in order to smooth consumption over their lifetime -it is accomplished with the help of the loanable funds market -people borrow early in life, save during midlife, and draw down savings during retirement

Dissaving

-occurs when people withdraw funds from their previously accumulated savings

Chain of Crucial Relationships

-output (GDP) requires investment; investment requires borrowing; borrowing requires savings -all the links in this chain require a loanable funds market that efficiently channels funds from savers to borrowers

Time Preferences

-refers to the fact that people prefer to receive goods and services sooner rather than later -if the rate of time preference in a society changes, the supply of loanable funds shifts -people with strong time preferences save less than people with weaker time preferences

Fisher Equation

-states that the real interest rate equals the nominal interest rate minutes the inflation rate

Crucial Market from the perspective of prices, quantities, supply, and demand

-the good in this market is loanable funds -the demanders (consumer) are borrowers; the suppliers are savers -this approach clarifies the role of interest rates

Real Interest Rate

-the interest rate is that is corrected for inflation

Loanable Funds Market

-the market where savers supply funds for loans to borrowers -this market is not a single physical location, but includes places like stock exchanges, investment banks, mutual fund firms, and commercial banks

A Decrease in the Supply of Loanable Funds

-the potential effects of the baby boomers' retirement will lead to a decrease in the supply of loanable funds -this shift means lower investment and lower GDP growth -foreigners may continue to increase savings in the US, and perhaps savings rates in the US may offset the effects of the baby boomers' retirement to keep interest rates low

The Role of the Loanable Funds Market

-the supplier of funds include households (private individuals and families) and foreign entities (foreign governments, firms, and private citizens that choose to save in the US) -without a well-functioning loanable funds market, future GDP dries up

Shifts in the Supply of Loanable Funds

-the supply of loanable funds shifts to the right (increases) when there are decreases in time preferences, increases in foreign income and wealth, and more people in midlife -the supply of loanable funds shifts to the left (reduces) when there are increases in time preferences, decreases in foreign income and wealth, and fewer people in midlife

Savings Rate Decline

-there has been a decline in personal savings -certain gains are not counted in personal savings; in addition to real estate gains, the gains from purchases of stocks and bonds are also not counted in personal savings -from 1980-2007: many people shifted their personal savings into real estate and stock markets -in 2008-2009: real estate and stock prices tumbled: personal savings rates climbed to 6%

A Decline in Investor Confidence

-when the overall economy slows, firms often reduce investment since they expect reduced sales in future periods; this move reflects a decline in investor confidence -when investment demand declines, the loanable funds model predicts lower interest rates and a lower equilibrium level of investment