CHAPTER 26 Savings, Investment Spending, and the Financial System PowerPoint® Slides by Can Erbil © 2005 Worth Publishers, all rights reserved

2 What you will learn in this chapter: The relationship between savings and investment spending About the loanable funds market, which shows how savers are matched with borrowers The purpose of the four principal types of assets: stocks, bonds, loans, and bank deposits How financial intermediaries help investors achieve diversification Some competing views of what determines stock prices and why stock market fluctuations can be a source of macroeconomic instability

3 The Savings–Investment Spending Identity in a Closed Economy In a closed economy: GDP = C + I + G S Private = GDP + TR − T − C S Government = T − TR − G NS = S Private + S Government = (GDP + TR − T − C) + (T − TR − G) = GDP − C − G Hence, I = NS Investment spending = National savings in a closed economy

4 Budget Surplus and Budget Deficit

5 The Savings–Investment Spending Identity in an Open Economy I = S Private + S Government + (IM – X) = NS + KI(10) Investment spending = National savings + Capital inflow in an open economy

6 The Savings-Investment Spending Identity in Open Economies: the United States and Japan 2003

7 The Demand for Loanable Funds

8 The Supply for Loanable Funds

9 Equilibrium in the Loanable Funds Market

10 Savings, Investment Spending, and Government Policy

11 Increasing Private Savings

12 The Financial System - Definitions  Wealth  Financial asset  Physical asset  Liability  Transaction costs  Financial risk

13 Risk-Averse Attitudes Toward Gain and Loss

14 Three Tasks of a Financial System  Reducing transaction costs  Reducing financial risk  Providing liquid assets

15 Financial Intermediaries  Mutual funds  Pension funds  Life insurance companies  Banks

16 Financial Fluctuations  Financial market fluctuations can be a source of macroeconomic instability.  Are markets irrational?  Policy makers assume neither that markets always behave rationally nor that they can outsmart them.

17 The End of Chapter 26 coming attraction: Chapter 27: Aggregate Supply and Aggregate Demand