Chapters 26 & 27Chapters 26 & 27

Twofer Day!!!Twofer Day!!!

Dark side videoDark side video

OverviewOverview Discussion of saving & investing Why is it so important Where does it come from How much does it cost LOANABLE FUNDS market graph CROWDING OUT 27 SLIDES

Discussion of saving & investing Why is it so important Where does it come from How much does it cost LOANABLE FUNDS market graph CROWDING OUT 27 SLIDES

Why does it all matter?Why does it all matter?

Last chapter focused on growth

How is that concept connected here?

Why is saving & investing critical?

Last chapter focused on growth

How is that concept connected here?

Why is saving & investing critical?

BUY CAPITAL, BUY CAPITALBUY CAPITAL, BUY CAPITAL More capital = higher productivity Higher productivity = higher output Higher output = more stuff

NOT SPENDING ALL YOUR MONEY IS CRITICAL

FORGOING PRESENT CONSUMPTION ALLOWS US TO INCREASE POTENITAL OUTPUT FOR THE FUTURE

LOOK AT THE GRAPH

More capital = higher productivity Higher productivity = higher output Higher output = more stuff

NOT SPENDING ALL YOUR MONEY IS CRITICAL

FORGOING PRESENT CONSUMPTION ALLOWS US TO INCREASE POTENITAL OUTPUT FOR THE FUTURE

LOOK AT THE GRAPH

Need to not spend…it allNeed to not spend…it all

Is GDP hurt? GDP = C + I + G + X When we don’t spend, we save What happens to the leftover money?

Banks loan it to other people who want to borrow

Is GDP hurt? GDP = C + I + G + X When we don’t spend, we save What happens to the leftover money?

Banks loan it to other people who want to borrow

Financial IntermediariesFinancial Intermediaries

Think about it as a picture FINANCIAL SYSTEM allows borrowers to connect w/ those w/ money to lend

FINANCIAL MARKETS involves these transactions

2 most common: Bond & Stock Markets

Think about it as a picture FINANCIAL SYSTEM allows borrowers to connect w/ those w/ money to lend

FINANCIAL MARKETS involves these transactions

2 most common: Bond & Stock Markets

They’re both MARKETSThey’re both MARKETS Governed by individual incentive & supply/demand

Bond Market: essentially a loan to person looking to borrow

Stock Market: part ownership in the endeavor itself

All about capital (money) going back & forth

Governed by individual incentive & supply/demand

Bond Market: essentially a loan to person looking to borrow

Stock Market: part ownership in the endeavor itself

All about capital (money) going back & forth

ReminderReminder

Money & currency are different…how? MONEY is anything that:

Medium of Exchange: buy & sell stuff Unit of Account: comparing values Store of Value: save for later

Financial intermediaries include banks, credit unions, savings & loan institutions, & MUTUAL FUNDS (DIVERSIFICATION)

Money & currency are different…how? MONEY is anything that:

Medium of Exchange: buy & sell stuff Unit of Account: comparing values Store of Value: save for later

Financial intermediaries include banks, credit unions, savings & loan institutions, & MUTUAL FUNDS (DIVERSIFICATION)

BreatherBreather

Following SavingFollowing Saving

Keeping track of money is important

Accountants do that for a living NATIONAL INCOME ACCOUNTING involves doing it on a national level

Most common thing to follow is GDP

Keeping track of money is important

Accountants do that for a living NATIONAL INCOME ACCOUNTING involves doing it on a national level

Most common thing to follow is GDP

CIGXCIGX

GDP (or Y) = CIGX For now we assume a CLOSED ECONOMY No foreign component (compared to OPEN)

Manipulating yields GDP-C-G=I Since any money not spent (by us or gov’t) is saved it becomes

S = I

GDP (or Y) = CIGX For now we assume a CLOSED ECONOMY No foreign component (compared to OPEN)

Manipulating yields GDP-C-G=I Since any money not spent (by us or gov’t) is saved it becomes

S = I

Saving = InvestingSaving = Investing Doesn’t matter who PRIVATE SAVING by us PUBLIC SAVING by gov’t

Results w/ BUDGET SURPLUS as compared to BUDGET DEFICIT

Saving occurs when you don’t spend Investing occurs when buy capital NOT THE SAME THING…but are equal to each other

Why?

Doesn’t matter who PRIVATE SAVING by us PUBLIC SAVING by gov’t

Results w/ BUDGET SURPLUS as compared to BUDGET DEFICIT

Saving occurs when you don’t spend Investing occurs when buy capital NOT THE SAME THING…but are equal to each other

Why?

Creates a New MarketCreates a New Market

Saving supplies money to be loaned (supply curve)

Investing creates demand to have money (demand curve)

Combine to form the LOANABLE FUNDS MARKET

Saving supplies money to be loaned (supply curve)

Investing creates demand to have money (demand curve)

Combine to form the LOANABLE FUNDS MARKET

Picture itPicture it

What happens when supply or demand changes?

What happens when supply or demand changes?

S&I are key to futureS&I are key to future

Absolutely must do it What helped cause the recession?

DISSAVING rate for years Gov’t trying to correct that

Absolutely must do it What helped cause the recession?

DISSAVING rate for years Gov’t trying to correct that

“Make” us do it“Make” us do it

1. Saving Incentives Current plan by Obama to match personal saving

2. Investment Incentives Currently count half of investment as tax credit

3. Gov’t Budget Surplus/Deficit Uhhh ohhh

1. Saving Incentives Current plan by Obama to match personal saving

2. Investment Incentives Currently count half of investment as tax credit

3. Gov’t Budget Surplus/Deficit Uhhh ohhh

What’s their impact on LF?

What’s their impact on LF?

1. Increases supply Lowers IR; more attractive to borrow

2. Increases demand Raises IR; less attractive to borrow

3. Greatly Increases demand Raises IR; less attractive to borrow

1. Increases supply Lowers IR; more attractive to borrow

2. Increases demand Raises IR; less attractive to borrow

3. Greatly Increases demand Raises IR; less attractive to borrow

Enter the Federal Reserve

Enter the Federal Reserve

Now saving 5% as country Seems huge, but still low

Balanced by companies not investing

Gov’t borrowing huge amounts IR should go up Held down by FED…discount rate at .25%

Now saving 5% as country Seems huge, but still low

Balanced by companies not investing

Gov’t borrowing huge amounts IR should go up Held down by FED…discount rate at .25%

What happens w/o FED?What happens w/o FED?

Gov’t borrowing increases demand Increases IR Makes us less likely to borrow/spend

Goal of their spending to increase GDP but doesn’t work

CROWDING OUT

Gov’t borrowing increases demand Increases IR Makes us less likely to borrow/spend

Goal of their spending to increase GDP but doesn’t work

CROWDING OUT

In theory it balancesIn theory it balances

Chart on page 578

Debt to GDP ratio predicted to drop to 15% by 2012

Where are we now???

Chart on page 578

Debt to GDP ratio predicted to drop to 15% by 2012

Where are we now???

BreatherBreather

What is all of that stuff?

What is all of that stuff?

No idea what Chapter 27 actually saying

We are going to focus on the RISK

No idea what Chapter 27 actually saying

We are going to focus on the RISK

Risk is the perpetual bad guy

Risk is the perpetual bad guy

It does nothing positive Reduces spending, makes us uncomfortable, eliminates wealth

Nobody wants to lose money RISK AVERSE

It does nothing positive Reduces spending, makes us uncomfortable, eliminates wealth

Nobody wants to lose money RISK AVERSE

Understanding riskUnderstanding risk

Just like playing the lottery

Risk spreading is very desirable

Add DIVERSIFICATION

Just like playing the lottery

Risk spreading is very desirable

Add DIVERSIFICATION

Case in pointCase in point

Think about insurance Why buy insurance (any type)? Essentially betting that something bad will happen

If you win (& it does) they pay If you lose, they keep your money

Think about insurance Why buy insurance (any type)? Essentially betting that something bad will happen

If you win (& it does) they pay If you lose, they keep your money

2 problems can arise2 problems can arise

1. Adverse Selection Those most likely to “win” also most likely to buy insurance

2. Moral Hazard Having insurance makes you more likely to use it

Act less safe b/c have insurance

1. Adverse Selection Those most likely to “win” also most likely to buy insurance

2. Moral Hazard Having insurance makes you more likely to use it

Act less safe b/c have insurance

RECAPRECAP

Answer the following: 1. Why is saving/investing critical?

2. What is the purpose of financial markets?

3. Draw the loanable funds graph

4. Define crowding out

Answer the following: 1. Why is saving/investing critical?

2. What is the purpose of financial markets?

3. Draw the loanable funds graph

4. Define crowding out