Chapter 13: Saving Investment and the Financial System- Macroeconomics

T

denote the amount that the government collects from households in taxes minus the amount it pays back to households in the form of transfer payments (such as Social Security and welfare).

Principle

eventual repayment of the amount borrowed

default

failure to pay back a loan (When bond buyers perceive that the probability of default is high, they demand a higher interest rate as compensation for this risk.)

Financial markets

financial institutions through which savers can directly provide funds to borrowers

Financial intermediaries

financial institutions through which savers can indirectly provide funds to borrowers

Bond buyer

is a lender (The ______ of a bond gives his money to Intel in exchange for this promise of interest and eventual repayment of the amount borrowed (called the principal).) (The ______ can hold the bond until maturity, or he can sell the bond at an earlier date to someone else)

medium of exchange

is an item that people can easily use to engage in transactions. bank's role in providing a ________ __ ________distinguishes it from many other financial institutions.

Gross Domostic Product

is both total income in an economy and the total expenditure on the economy's output of goods and services GDP (denoted as Y) is divided into four components of expenditure: consumption (C), investment (I), government purchases (G), and net exports (NX)

stock index

is computed as an average of a group of stock prices.

closed economy

is one that does not interact with other economies. In particular, a closed economy does not engage in international trade in goods and services, and it does not engage in international borrowing and lending. (In this chapter, we simplify our analysis by assuming that the economy we are examining is closed)

nominal interest rate

is the monetary return to saving and the monetary cost of borrowing. It is the interest rate as usually reported.

real interest rate

is the nominal interest rate corrected for inflation; it equals the nominal interest rate minus the inflation rate. the supply and demand for loanable funds depend on the real (rather than nominal) interest rate,

interest rate

is the price of a loan. It represents the amount that borrowers pay for loans and the amount that lenders receive on their saving.

TIPS

offer inflation protection, they pay a lower interest rate than similar bonds without this feature.

Savers

people who spend less than they earn ( ______supply their money to the financial system with the expectation that they will get it back with interest at a later date.)

Borrowers

people who spend more than they earn ( _________demand money from the financial system with the knowledge that they will be required to pay it back with interest at a later date.)

investment

refers to the purchase of new capital, such as equipment or buildings. When Moe borrows from the bank to build himself a new house, he adds to the nation's investment.

Accounting

refers to the way in which various numbers are defined and added up.

Saving and Investment

the bond market, the stock market, banks, and mutual funds—serve the role of coordinating the economy's ________ ____ ___________. (_______ ___ __________ are important determinants of long-run growth in GDP and living standards.)

taxable income

the bond owner has to pay a portion of the interest he earns in income taxes.

municipal bonds

the bond owners are not required to pay federal income tax on the interest income. (Because of this tax advantage, bonds issued by state and local governments typically pay a lower interest rate than bonds issued by corporations or the federal government.)

demand

the demanders of loanable funds people who want to invest

private saving

the income that households have left after paying for taxes and consumption In particular, because households receive income of Y, pay taxes of T, and spend on consumption C, private saving is Y-T-C

bond's term

the length of time until the bond matures. (One of the four important characteristic of a Bond) (Some bonds have short terms, such as a few months, while others have terms as long as thirty years.)

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 (All savers go to this market to deposit their saving, and all borrowers go to this market to take out their loans.) To keep things simple, we assume that the economy has only one financial market, called the _____ ___ ______ ____.

credit risk

the probability that the borrower will fail to pay some of the interest or principal. (One of the four most important characteristic of a Bond)

debt finance

the sale of bonds to make money

supply

the suppliers of loanable funds people who want to save

Public saving

the tax revenue that the government has left after paying for its spending The government receives in tax revenue T and spends on goods and services G. If exceeds, the government receives more money than it spends. T-G

national saving

the total income in the economy that remains after paying for consumption and government purchases. (Represents Y-C-G) (Can also represent S)

tax treatment

the way the tax laws treat the interest earned on the bond. (One of the four important characteristic of a Bond)

Store of value

the wealth that people have accumulated in past saving (While stocks and bonds, like bank deposits, offer a possible ____ __ _____ for the wealth that people have accumulated in past saving, they do not offer the easy, cheap, and immediate access to wealth that writing a check or swiping a debit card allows.

open economy

they interact with other economies around the world. (Actual economies are open economies)

long-term bonds

usually pay higher interest rates than short-term bonds. (Long-term bonds are riskier than short-term bonds because holders of long-term bonds have to wait longer for repayment of principal. If a holder of a long-term bond needs his money earlier than the distant date of maturity, he has no choice but to sell the bond to someone else)

Index funds

which buy all the stocks in a given stock index, perform somewhat better on average than mutual funds that take advantage of active trading by professional money managers.

junk bonds

High-risk, high-interest bonds

inflation protection.

If prices rise and dollars have less purchasing power, the bondholder is worse off. Some bonds, however, index the payments of interest and principal to a measure of inflation so that when prices rise, the payments rise proportionately. (One of the four important characteristic of a Bond)

supplied

If the interest rate were lower than the equilibrium level, the quantity of loanable funds _________ would be less than the quantity of loanable funds demanded.

national saving equation

S = (Y - T - C) + (T - G) S=Y-C-G

saving equals investment

S=I Although the accounting identity S=I shows that saving and investment are equal for the economy as a whole, it does not mean that saving and investment are equal for every individual household or firm.

saving example

Suppose that Larry earns more than he spends and deposits his unspent income in a bank or uses it to buy some stock or a bond from a corporation. Because Larry's income exceeds his consumption, he adds to the nation's saving. Larry might think of himself as "investing" his money, but a macroeconomist would call Larry's act saving rather than investment.

supply of loanable funds

The ____ __ _____ ____comes from people who have some extra income they want to save and lend out. This lending can occur directly, such as when a household buys a bond from a firm, or it can occur indirectly, such as when a household makes a deposit in a bank, which then uses the funds to make loans. In both cases, saving is the source of the _____ ___ ____ ____.

demand for loanable funds

The _____ __ _______ ______comes from households and firms who wish to borrow to make investments. This demand includes families taking out mortgages to buy new homes. It also includes firms borrowing to buy new equipment or build factories. In both cases, investment is the source of the _____ ___ ____ _____.

shareholder

The ________ of the mutual fund accepts all the risk and return associated with the portfolio. If the value of the portfolio rises, the __________ benefits; if the value of the portfolio falls, the ___________ suffers the loss.

Primary Advantage

The _________ _________of mutual funds is that they allow people with small amounts of money to diversify their holdings. Mutual funds make this diversification easy. With only a few hundred dollars, a person can buy shares in a mutual fund and, indirectly, become the part owner or creditor of hundreds of major companies. (Because the value of any single stock or bond is tied to the fortunes of one company, holding a single kind of stock or bond is very risky. By contrast, people who hold a diverse portfolio of stocks and bonds face less risk because they have only a small stake in each company.)

Date of maturity

The bond identifies the time at which the loan will be repaid, called the ____ __ ______.

loanable funds

The economy's market for ________ ____, like other markets in the economy, is governed by supply and demand.

Financial System

The group of institutions in the economy that help to math one person's saving with another person's investment (saving and investment are key ingredients to long-run economic growth) is made up of various financial institutions that help coordinate the actions of savers and borrowers.

identity

The rules of national income accounting include several important identities. Recall that an __________ is an equation that must be true because of the way the variables in the equation are defined.

equity finance

The sale of stock to raise money

Intermediary

The term ________reflects the role of these institutions in standing between savers and borrowers.

1. Bond's Term 2. Credit Risk 3. Tax Treatment 4. Inflation Protection

What are the 4 most important characteristic of a Bond?

banks and mutual funds

What are the two most important financial intermediaries?

Bond Market and Stock Market

What are the two most important financial markets in our economy?

Banks

A primary job of ____ is to take in deposits from people who want to save and use these deposits to make loans to people who want to borrow. They facilitate purchases of goods and services by allowing people to write checks against their deposits and to access those deposits with debit cards. ( ____ pay depositors interest on their deposits and charge borrowers slightly higher interest on their loans) (One of the two most important financial intermediaries)

second advantage

A second advantage claimed by mutual fund companies is that mutual funds give ordinary people access to the skills of professional money managers. (The managers of most mutual funds pay close attention to the developments and prospects of the companies in which they buy stock. These managers buy the stock of companies they view as having a profitable future and sell the stock of companies with less promising prospects.)

Directing the resources of savers into the hands of borrowers

All financial institutions are all very different but all serve the same goal. (Such as Bond markets, stock markets, banks, and mutual funds) An what is that goal?

low credit risk

If you have LOW CREDIT RISKS, you tend to pay low interest rates

nominal terms

Most bonds are written in _______ ____—that is, they promise to pay interest and principal in a specific number of dollars (or perhaps another currency)

Private saving and Public saving

National saving is separated into two pieces. What are the two pieces?

closed economy equation

Y=C+I+G This equation states that GDP is the sum of consumption, investment, and government purchases. Each unit of output sold in a closed economy is consumed, invested, or bought by the government. (there are no imports and exports, making net exports NX exactly zero.)

GDP

Y=C+I+G+NX (This equation is an identity because every dollar of expenditure that shows up on the left side also shows up in one of the four components on the right side. Because of the way each of the variables is defined and measured, this equation must always hold.)

Financial institutions

_______ ________can be grouped into two categories: financial markets and financial intermediaries.

perpetuity

a bond that never matures. (Specifically a bond that does not have a due date)

stock

a claim to partial ownership in a firm and is, therefore, a claim to some of the profits that the firm makes. (The owner of shares of Intel stock is a part owner of Intel, while the owner of an Intel bond is a creditor of the corporation. If Intel is very profitable, the stockholders enjoy the benefits of these profits, whereas the bondholders get only the stated interest on their bonds. And if Intel runs into financial difficulty, the bondholders are paid what they are due before stockholders receive anything at all) (stocks carry greater risk but offer potentially higher returns.)

budget deficit

a shortfall of tax revenue from government spending If G exceeds T , the government spends more than it receives in tax revenue. In this case, public saving is negative, and the government is said to run a ________ ________.

budget surplus

an excess of tax revenue over government spending If T exceeds G, the government receives more money than it spends. In this case, public saving (T-G) is positive, and the government is said to run a ________ _______.

Mutual Funds

an institution that sells shares to the public and uses the proceeds to buy a portfolio of stocks and bonds (One of the two most important financial intermediaries)

saving

high interest rate makes _______ more attractive, the quantity of loanable funds supplied rises as the interest rate rises.

Borrowing

high interest rate makes ___________ more expensive, the quantity of loanable funds demanded falls as the interest rate rises.

borrowing

high interest rate makes _______more expensive, the quantity of loanable funds demanded falls as the interest rate rises.

Demanded

if the interest rate were higher than the equilibrium level, the quantity of loanable funds supplied would exceed the quantity of loanable funds _____________.

bond

is a certificate of indebtedness that specifies the obligations of the borrower to the buyer of the bond. (is an IOU)