1.
The previous chapter we discussed that when a country saves a large portion of its GDP, more resources
are available for investment in captital, and higher capital rises a country’s productivity and living standard.
Nut we did not explain how the economy coordinate saving and investment. Now we continue to find what
is the meaning of saving and investment in the economy and how the financial system works.
2. First, we discuss the large variety of institutions that make up the financial system.
Second, we discuss the relationship between the financial system and some key macroeconomic variables.
Third, we develop a model of the supply and demand for funds in financial markets.
3.Now, let’s start the first part – financial system in the economy. Firstly, we’ll have a brief look at somw
definitions. Financial system consists of the institutions that help to match one person’s saving with another
person’s investment.
4. The financial system moves the economy’s scarce resources from savers to borrowers….
Now to be more understand about this system, let’s discuss the most important institutions of it. Financial
institutions can be grouped into 2 categories: Financial market and Financial intermediaries. We consider
each category in turn.
5, … The 2 most important financial markets in the economy are the bond market and the stock market.
6. When a firm wants to borrow finance to build a new factory, that Firms can borrow directly from the
public by selling bonds. Its identifies the time at which the loan will be repaid, called Date of maturity and
the rate of interest will be paid periodically.
Trái phiếu là 1 chứng nhận nghĩa vụ nợ của ng phát hành phải trả cho ng sở hữu trái phiếu 1 khoản tiền cụ
thể trong thời gian xác định và với 1 lợi tức nhẩt định.
7. There are millions of different bonds in the economy, when a large company or the government need to
borrow to finance the purchases: new factory, new school,.. But they have 3 main characteristics
1. the first characteristic is a bond’s term:
8. whereas the sale of bonds is called debt finance (tài trợ = vay nợ)
9. After issued stock exchanges among stockholders the corporation itself receives no money when
its stock changes hands
The prices at which shares trade on stock exchanges are determined by the
supply of and demand for the stock in these companies. Because stock represents ownership in a
corporation, the demand for a stock (and thus its price) reflects people’s perception of the corporation’s
future profitability. When people become optimistic about a company’s future, they raise their demand for
its stock and thereby bid up the price of a share of stock. Conversely, when people come to expect a
company to have little profit or even losses, the price of a share falls.
10.
11. If the owner of a small grocery store wants to finance an expansion of his business, he would find it
difficult to raise funds in the bond and stock markets. The small grocer, therefore, most likely finances his
business expansion with a loan from a local bank.
Banks are the financial intermediaries with which people are most familiar. A primary job of banks is to take
in deposits from people who want to save and use these deposits to make loans to people who want to
borrow. Banks pay depositors interest on their deposits and charge borrowers slightly higher interest on their
loans. The difference between these rates of interest covers the banks’ costs and returns some profit to the
owners of the banks.
12.
13. The primary advantage of mutual funds is that they allow people with small amounts of money to
diversify their holdings. Buyers of stocks and bonds are well advised to heed the adage: Don’t put all your
eggs in one basket. 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. Mutual funds make
this diversification easy. With only a few hun dred dollars, a person can buy shares in a mutual fund and,
indirectly, become the part owner or creditor of hundreds of major companies. For this service, the company
operating the mutual fund charges shareholders a fee, usually between 0.5 and 2.0 percent of assets each
year.
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. This professional management, it is argued, should increase the return that mutual fund depositors
earn on their savings.
Financial economists, however, are often skeptical of this second argument. With thousands of money
managers paying close attention to each company’s prospects, the price of a company’s stock is usually a
good reflection of the company’s true value. As a result, it is hard to “beat the market” by buying good
stocks and selling bad ones. In fact, mutual funds called index funds, which buy all the stocks in a given
stock index, perform somewhat better on average than mutual funds that take ddvantage of active trading by
professional money managers. The explanation for the superior performance of index funds is that they keep
costs low by buying and selling very rarely and by not having to pay the salaries of the professional money
managers.
14.
15. Events that occur within the financial system are central to understanding evelopments in the overall
economy. As a result, macroeconomists need to understand how financial markets work and how various
events and policies affect them.
A personal accountant might help an individual add up her income and expenses. A national income
accountant does the same thing for the economy as a whole. Here we consider some accounting identities
that shed light on the macroeconomic role of financial markets.
16. Now consider how these accounting identities are related to financial markets. The equation S = I reveals
an important fact: For the economy as a whole, saving must be equal to investment. Yet this fact raises some
important questions: What mechanisms lie behind this identity? What coordinates those people who are
deciding how much to save and those people who are deciding how much to invest? The answer is the
financial system. The bond market, the stock market, banks, mutual funds, and other financial markets and
intermediaries stand between the two sides of the S = I equation. They take in the nation’s saving and direct
it to the nation’s investment.
17.
18. Consider an 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.
In the language of macroeconomics, 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. (Remember, the purchase of a new house is
the one form of household spending that is investment rather than consumption.) Similarly, when the Curly
Corporation sells some stock and uses the proceeds to build a new factory, it also adds to the nation’s
investment.
19.
20.
21. Saving is the source of the supply of loanable funds
Investment is the source of the demand for loanable funds
The interest rate is the price of a loan
- Borrowers pay for loans
- Lenders receive on their saving
The interest rate balances the supply and demand for loanable funds
The adjustment of the interest rate to the equilibrium level occurs for the usual reasons. If the interest rate
were lower than the equilibrium level, the quantity of loanable funds supplied would be less than the
quantity of loanable funds demanded. The resulting shortage of loanable funds would encourage lenders to
raise the interest rate they charge. A higher interest rate would encourage saving (thereby increasing the
quantity of loanable funds supplied) and discourage borrowing for investment (thereby decreasing the
quantity of loanable funds demanded). Conversely, if the interest rate were higher than the equilibrium level,
the quantity of loanable funds supplied would exceed the quantity of loanable funds demanded. As lenders
competed for the scarce borrowers, interest rates would be driven down. In this way, the interest rate
approaches the equilibrium level at which the supply and demand for loanable funds exactly balance.
Recall that economists distinguish between the real interest rate and the nominal interest rate. The nominal
interest rate is the interest rate as usually reported—the monetary return to saving and the monetary cost of
borrowing. The real interest rate is the nominal interest rate corrected for inflation; it equals the nominal
interest rate minus the inflation rate. Because inflation erodes the value of money over time, the real interest
rate more accurately reflects the real return to saving and the real cost of borrowing. Therefore, the supply
and demand for loanable funds depend on the real (rather than nominal) interest rate, and the equilibrium in
Figure 1 should be interpreted as determining the real interest rate
This model of the supply and demand for loanable funds shows that financial markets work much like other
markets in the economy. In the market for milk, for instance, the price of milk adjusts so that the quantity of
milk supplied balances the quantity of milk demanded. In this way, the invisible hand coordinates the
behavior of dairy farmers and the behavior of milk drinkers. Once we realizethat saving represents the
supply of loanable funds and investment represents the demand, we can see how the invisible hand
coordinates saving and investment. When the interest rate adjusts to balance supply and demand in the
market for loanable funds, it coordinates the behavior of people who want to save (the suppliers of loanable
funds) and the behavior of people who want to invest (the demanders of loanable funds).
22. First, which curve would this policy affect? Because the tax change would alter the incentive for
households to save at any given interest rate, it would affect the quantity of loanable funds supplied at each
interest rate. Thus, the supply of loanable funds would shift. The demand for loanable funds would remain
the same because the tax change would not directly affect the amount that borrowers want to borrow at any
given interest rate
Second, which way would the supply curve shift? Because saving would be taxed less heavily than under
current law, households would increase their saving by consuming a smaller fraction of their income.
Households would use this additional saving to increase their deposits in banks or to buy more bonds. The
supply of loanable funds would increase, and the supply curve would shift to the right from S1 to S2, as
shown in Figure 2.
Finally, we can compare the old and new equilibria. In the figure, the increased supply of loanable funds
reduces the interest rate from 5 percent to 4 percent. The lower interest rate raises the quantity of loanable
funds demanded from $1,200 billion to $1,600 billion. That is, the shift in the supply curve moves the
market equilibrium along the demand curve. With a lower cost of borrowing, households and firms are
motivated to borrow more to finance greater investment. Thus, if a reform of the tax laws encouraged
greater saving, the result would be lower interest rates and greater investment.
23. First, would the law affect supply or demand? Because the tax credit would reward firms that borrow
and invest in new capital, it would alter investment at any given interest rate and, thereby, change the
demand for loanable funds. By contrast, because the tax credit would not affect the amount that households
save at any given interest rate, it would not affect the supply of loanable funds.
Second, which way would the demand curve shift? Because firms would have an incentive to increase
investment at any interest rate, the quantity of loanable funds demanded would be higher at any given
interest rate. Thus, the demand curve for loanable funds would move to the right, as shown by the shift from
D1 to D2 in the figure.
Third, consider how the equilibrium would change. In Figure 3, the increased demand for loanable funds
raises the interest rate from 5 percent to 6 percent, and the higher interest rate in turn increases the quantity
of loanable funds supplied from $1,200 billion to $1,400 billion, as households respond by increasing the
amount they save. This change in household behavior is represented here as a movement along the supply
curve. Thus, if a reform of the tax laws encouraged greater investment, the result would be higher interest
rates and greater saving.
24. First, which curve shifts when the government starts running a budget deficit? Recall that national saving
—the source of the supply of loanable funds—is composed of private saving and public saving. A change in
the government budget balance represents a change in public saving and, thereby, in the supply of loanable
funds. Because the budget deficit does not influence the amount that households and firms want to borrow to
finance investment at any given interest rate, it does not alter the demand for loanable funds.
Second, which way does the supply curve shift? When the government runs a budget deficit, public saving is
negative, and this reduces national saving. In other words, when the government borrows to finance its
budget deficit, it reduces the supply of loanable funds available to finance investment by households and
firms. Thus, a budget deficit shifts the supply curve for loanable funds to the left from S 1 to S2, as shown in
Figure 4.
Third, we can compare the old and new equilibria. In the figure, when the budget deficit reduces the supply
of loanable funds, the interest rate rises from 5 percent to 6 percent. This higher interest rate then alters the
behavior of the households and firms that participate in the loan market. In particular, many demanders of
loanable funds are discouraged by the higher interest rate. Fewer families buy new homes, and fewer firms
choose to build new factories. The fall in investment because of government borrowing is called crowding
out and is represented in the figure by the movement along the demand curve from a quantity of $1,200
billion in loanable funds to a quantity of $800 billion. That is, when the government borrows to finance its
budget deficit, it crowds out private borrowers who are trying to finance investment.
