CH10 beginning Flashcards
financial markets
markets in which the government, firms and individuals trade promises to pay in future (instead of goods)
savings-investment spending identity
savings and investment spending are always equal for the economy as a whole
investment spending
spending/investing in new physical capital
–> only spending that adds to the economy’s stocl of physical capital is considered investment spending
inflow of funds
foreign savings that finance investment spending in that country
outflow of funds
domestic savings that finance investment spending in another country
net capital inflow (equation)
total inflow of funds into a country– the total outflow of funds out of a country
economy with positive net capital inflow…
some investment spending funded by savings of foreigners–> more capital flowing in than out
economy with negative net capital inflow…
portion of national savings is funding investment spedning in other countries–> more capital flowing out than in
for economy as a whole
savings=investment spending
in closed economy
savings=national savings
in open economy
savings=national savings+capital inflow
loanable funds market
hypothetical market that illustrates the market outcome of the demand for funds generated by borrowers and the supply of funds provided by lenders
equilibrium interest rate
the interest rate at which the quantity of loanable funds supplied equals the quantity of loanable funds demanded
2 factors that cause shift of DEmand curve for loanable funds:
- changes in perceived business opportunities
- changes in government borrowing
changes in perceived business opportunities (explain)
Change in beliefs about the payoff of investment spending can increase/decrease the amount of desired spending at any given interest rate
Example: in ‘90s great excitement about business possibilities created by the internet→ business rushed to invest in computer equipment, internet cables etc→ resulting in shift to right of demand curve for loanable funds
changes in government borrowing (explain)
If government run a budget deficit can be major source of demand for loanable funds
–> Other things equal, government budget deficits tend to reduce overall spending→ shifts demand curve for loanable funds to right→ leads to higher interest wage→ and if interest rate rises, business cut back on their investment spending (which is bad for the economy)
crowding out
occurs when government budget deficit drives up the interest rate and leads to reduced investment spending
–> crowding out may not occur when economy is depressed–> because less employment–> government spending can lead to higher incomes–> these might lead to increased savings at any given interest rate
2 factors that shift Supply curve of loanable funds:
- changes in private savings behaviour
- changes in net capital inflow
changes in private savings behaviour (explain)
can change at any given interest rate because of number of factors
–> example: following corona pandemic+concerns of growing recession households cut back on spending–> resulting in increase of savings–> shift of supply cirve of loanable funds to right
changes in net capital inflows (explain)
capital flows in+out of country can change as investors perception of country changes
–> Example: in 1999 after creation of euro, large net capital inflow Greece because investors believed that because Greece’s adoption of euro as currency made it safe place to put their funds→ shift to right
→ however in 2009 worries about Greek government’s solvency (and that had been understating its debt) led to collapse in investor confidence→ shrinking of capital inflows→ resulting in shift of supply curve in Greek loanable funds market to left
global loanable funds market
arises when international capital flows are so large that they equalise interest rates across countries
fisher effect (definition)
an increase in expected future inflation drives up nominal interest rate, leaving the expected real interest rate unchanged
→ each additional percentage point of expected future inflation drives up the nominal interest rate by 1 percentage point
→ both lenders+borrowers base their decisions on expected real interest rate→ result: change in expected rate of inflation doesn’t affect the equilibrium quantity of loanable funds or the expected real interest wage→ all it affects is the equilibrium nominal interest rate
financial markets (definition)
where households invest theur current+accumulated savings
(a households) wealth (definition)
the value of accumulated savings
financial asset
a paper claim that entitles the buyer to future income from the seller
–> like a loan
physical asset (definition)
a tangible object that can be used to generate future income
–> like pre-existing house or piece of equipment–> purchasing physical asset gives owner right to dispose of object how they wish (like rent/sell it)
investing (definition)
the purchase of a financial/physical asset
investment spending (definition)
spend funds that add to the stock of physical capital in the economy
liability
a requirement to pay income in the future
→ so if get a loan from your bank (financial asset) also creating a liability→ so even though loan is financial asset from banks pov, it’s a liability from your pov
4 kinds of important financial assets:
- loans
- bonds
- bank deposits
3 tasks of financial system –> to enhance efficiency of financial markets+make more likely lenders+borrowers make mutually beneficial trades that make society as whole richer
- reducing transaction costs’
- reducing risk
- providing liquidity
transactional costs (definition)
the expenses of negotiating and executing a deal
reducing transaction costs (explain)
When large business want to borrow money: either go bank or sell bonds in bond market→ obtaining loan from bank avoids large transaction costs because only involving one single borrower and one single lender→ and the bond market exists to allow companies to borrow large sums of money without incurring large transaction costs
