Chapter 13: Saving, Investment, and the Financial System


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Chapter 13: Saving, Investment, and the Financial System

  1. 1. Chapter 13 Saving, Investment, and the Financial System
  2. 2. Outline <ul><li>Coordination of savings and investment by the economy </li></ul><ul><li>Working of the financial system and its constitution </li></ul><ul><li>Develop a model of supply and demand for funds </li></ul><ul><li>Impact of government policies on interest rate </li></ul>
  3. 3. Financial System in Canada <ul><li>Financial system is a group of institutions in the economy that help to match one person’s saving with another person’s investment. </li></ul><ul><li>It is made up of a number of financial institutions. Broadly of two types </li></ul><ul><ul><li>Financial markets </li></ul></ul><ul><ul><li>Financial Intermediaries </li></ul></ul>
  4. 4. Financial Markets <ul><li>Financial markets are institutions through which savers can directly provide funds to borrowers </li></ul><ul><ul><li>The bond market </li></ul></ul><ul><ul><li>The stock market </li></ul></ul><ul><li>The bond is a certificate of indebtedness and has two important characteristics </li></ul><ul><ul><li>Term of the bond (date of maturity) </li></ul></ul><ul><ul><li>Credit risk- probability of default by the borrower </li></ul></ul><ul><ul><li>Tax assessment: Interest rate on most bonds is subject to a tax </li></ul></ul>
  5. 5. Financial Markets <ul><li>The stock market: Stock is a claim to partial ownership of firm and issue of stock is done through sale of shares to the public </li></ul><ul><li>Equity finance versus debt finance </li></ul><ul><li>The prices at which shares trade on stock exchange are determined by the supply and demand for the stock in the company </li></ul><ul><li>Equity premium- bonus paid by the market to shareholders </li></ul><ul><li>Stock index is the average of a group of stock prices </li></ul>
  6. 6. Financial Intermediaries <ul><li>Financial intermediaries are financial institutions through which savers ca indirectly provide funds to borrowers </li></ul><ul><ul><li>Banks </li></ul></ul><ul><ul><li>Mutual funds </li></ul></ul><ul><li>Banks help create a special asset (cheques against deposits) that functions as a medium of exchange </li></ul>
  7. 7. Financial Intermediaries <ul><li>Mutual fund is an institution that sells shares to the public and uses the proceeds to buy a portfolio of stocks and bonds </li></ul><ul><li>The shareholder of the mutual fund accepts the risks and returns associated with the mutual fund </li></ul><ul><ul><li>Helps small savers to diversify risk </li></ul></ul>
  8. 8. Reading the Newspaper’s stock tables
  9. 9. Reading an online Quote
  10. 10. S and I in the National Income Accounts <ul><li>S and I are important determinants of LR growth in GDP and standards of living of a nation </li></ul><ul><li>Recall: Y = C + I + G + NX </li></ul><ul><li>Assume a closed economy </li></ul><ul><li>There are two components to national saving: </li></ul><ul><ul><li>Public saving </li></ul></ul><ul><ul><li>Private saving </li></ul></ul>
  11. 11. S and I in the National Income Accounts <ul><li>For the economy as a whole, saving must be equal to investment </li></ul><ul><li>The concept and calculation of Present Value </li></ul>
  12. 12. The Market For Loanable Funds <ul><li>Financial markets co-ordinate the economy’s saving and investment in the Loanable Funds Market </li></ul><ul><li>Saving represents the supply of loanable funds </li></ul><ul><li>Investment represents demand for loanable funds </li></ul><ul><li>The supply and demand for loanable funds depends on the real interest rate </li></ul><ul><li>Equilibrium determines the real interest rate in the economy </li></ul>
  13. 13. Government Policy and Economy’s Saving and Investment <ul><li>Policies that influence the loanable funds market: </li></ul><ul><ul><li>Tax incentives and Saving </li></ul></ul><ul><ul><ul><li>Tax incentives that encourage savings would result in lower interest rates and greater investment </li></ul></ul></ul><ul><ul><li>Tax credits and Investment </li></ul></ul><ul><ul><ul><li>Tax credits that encourage investment would result in higher interest rates and greater saving </li></ul></ul></ul><ul><ul><li>Government Budget Deficits/Surpluses </li></ul></ul>
  14. 14. Government Policy and Economy’s Saving and Investment <ul><li>Government Budget Deficits </li></ul><ul><ul><li>Impacts adversely on national saving </li></ul></ul><ul><ul><li>Government borrowing crowds out private investment </li></ul></ul><ul><ul><li>Budget deficits and vicious circle </li></ul></ul><ul><ul><li>Budget surplus and virtuous circle </li></ul></ul><ul><li>Accumulation of government debt in Canada </li></ul><ul><ul><li>Policies undertaken by the federal and provincial governments </li></ul></ul>
  17. 18. Savings and Investment in Canada as % of GDP 1961-2001