Econ 2301Econ 2301MacroeconomicsMacroeconomics

Dr. JacobsonDr. Jacobson

Mr. (Coach) StuckeyMr. (Coach) Stuckey

Chapter 10Chapter 10

SavingsSavingsInvestment SpendingInvestment Spending

and theand theFinancial SystemFinancial System

National National SavingsSavingsNational National SavingsSavings

What is it?What is it?What is it?What is it?National Savings is the total National Savings is the total

income in the economy that income in the economy that remains after paying for remains after paying for consumption and consumption and government purchases.government purchases.

The portion of the nation’s The portion of the nation’s income that is not consumed.income that is not consumed.

Equation for National Equation for National SavingsSavings

Equation for National Equation for National SavingsSavings

S=Y-C-GS=Y-C-G

S=IS=I

S=Y-C-GS=Y-C-G

S=IS=IS=National Savings, Y=GDP, C=Consumption, G=Government Purchases, I=InvestmentS=National Savings, Y=GDP, C=Consumption, G=Government Purchases, I=Investment

GDP Y=C+I+G

Savings=InvestmeSavings=Investmentnt

Savings has to equal Savings has to equal investments for the economy investments for the economy as a whole, but not for every as a whole, but not for every individual.individual.

The bond market, stock The bond market, stock market, banks, mutual funds market, banks, mutual funds and other financial markets and other financial markets take the nation’s savings and take the nation’s savings and direct it to the nation’s direct it to the nation’s investment.investment.

National SavingsNational SavingsRepresents resources available for Represents resources available for

investment to do things like replace investment to do things like replace old factories and equipment, or to old factories and equipment, or to buy more and better capital goods.buy more and better capital goods.

Plays a major role in our nation’s Plays a major role in our nation’s long-term economic growth and long-term economic growth and future living standards.future living standards.

Higher savings and investment Higher savings and investment contribute to increased productivity contribute to increased productivity and stronger economic growth.and stronger economic growth.

The United States net national The United States net national savings is less than 1% of the savings is less than 1% of the

GDPGDP

The net national savings rate has not been this low since the The net national savings rate has not been this low since the Great Depression.Great Depression.

Positivity of National Positivity of National SavingsSavings

Savings is the main Savings is the main source of funds source of funds available for available for domestic investment domestic investment in new capital goods.in new capital goods.

Ways to Higher National Ways to Higher National SavingsSavings

Tax ReformsTax ReformsBudget DeficitBudget DeficitSocial SecuritySocial Security

Tax ReformsTax ReformsMake the tax code Make the tax code

simpler, more fair, and to simpler, more fair, and to further promote savings, further promote savings, and job creationand job creation

Reduce the bias against Reduce the bias against savings and investment savings and investment inherent in the current inherent in the current system.system.

Budget DeficitBudget DeficitCreate a plan to Create a plan to reduce the deficit over reduce the deficit over time relative to the time relative to the size of the economy.size of the economy.

Restrain government Restrain government spending growthspending growth

Social Security Social Security ReformReform

Restoring Social Security to Restoring Social Security to sustainable solvency and sustainable solvency and increasing saving are increasing saving are intertwined national goals.intertwined national goals.

The way in which Social The way in which Social Security is reformed will Security is reformed will influence both the magnitude influence both the magnitude and timing of any increase in and timing of any increase in national savings.national savings.

Negativity of National Negativity of National SavingsSavings

National savings has been National savings has been in the red in past years.in the red in past years.

The net national savings The net national savings rate has not been this low rate has not been this low since the Great Depression.since the Great Depression.

Things are not looking too Things are not looking too good for the future either.good for the future either.

National debt sky high, National debt sky high, savings not.savings not.

Fear and obsession Fear and obsession regarding consumer regarding consumer spending continues, the fact spending continues, the fact is that the beginning of the is that the beginning of the 21st century has not been 21st century has not been troubled with excessive troubled with excessive savings, but by a serious savings, but by a serious dearth in savings.dearth in savings.

Consequences of Negative Consequences of Negative SavingsSavings

Negative savings rate Negative savings rate implies a negative trade implies a negative trade balance.balance.

American households are American households are whittling down their wealth.whittling down their wealth.

Negative national savings Negative national savings means that the nation is not means that the nation is not accumulating capitalaccumulating capital

How Many of You How Many of You Would Like to Either Would Like to Either

Start Your Own Start Your Own Business or Take Over Business or Take Over

a Family Business?a Family Business?

Lack of Money or Not Lack of Money or Not Enough Money is the Enough Money is the

Cause of Most Start-up Cause of Most Start-up Businesses Going Businesses Going

Broke.Broke.

Many People Have Many People Have Great Ideas and Even Great Ideas and Even Great Products That Great Products That

Can Not Make a Go of Can Not Make a Go of It. Why?It. Why?Usually Usually

Implementation!Implementation!

ImplementationImplementation

Usually Means Money Usually Means Money or Lack thereof.or Lack thereof.

Where Can One Go Where Can One Go To Get the To Get the

Necessary Capital?Necessary Capital?

Places to Get CapitalPlaces to Get CapitalMoney From Friends.Money From Friends.Mortgage Your House.Mortgage Your House.Relatives.Relatives.Sell Assets.Sell Assets.Banks.Banks.Venture Capitalists.Venture Capitalists.Sell Stock.Sell Stock.Find Investors.Find Investors.

In the Last Chapter We In the Last Chapter We Looked at the Various Looked at the Various Ways for a Country to Ways for a Country to

Increase its Increase its Production.Production.

When People Start When People Start New Businesses Can New Businesses Can Not That Increase a Not That Increase a

Nations GDP?Nations GDP?

In this Chapter We are In this Chapter We are Going to Explore the Going to Explore the

Various Methods Various Methods Nations, Companies Nations, Companies

and Individuals Use to and Individuals Use to Either Raise Capital or Either Raise Capital or

Invest.Invest.

In Short:In Short:

What is the Engine What is the Engine Driving Production Driving Production With the Needed With the Needed

Capital?Capital?

In the Last Chapter We In the Last Chapter We Saw How Savings and Saw How Savings and Investment Are Key Investment Are Key Ingredients to Long Ingredients to Long

Term Economic Term Economic Growth.Growth.

In an Economy There Are:In an Economy There Are:

Savers- People Who Savers- People Who Spend Less Then They Spend Less Then They Earn.Earn.

Borrowers- People Who Borrowers- People Who Spend More Than They Spend More Than They Earn.Earn.

The Financial System The Financial System Is the Various Is the Various

Institutions That Institutions That Brings Savers and Brings Savers and

Borrowers Together.Borrowers Together.

The Financial System-The Financial System-

The Group of Institutions The Group of Institutions in The Economy That Help in The Economy That Help

to Match One Person’s to Match One Person’s Savings With Another Savings With Another Person’s Investment.Person’s Investment.

How Does the How Does the Financial System Financial System

Work?Work?

Financial Institutions Can Financial Institutions Can Be Grouped Into Two Be Grouped Into Two Categories:Categories:

1. Financial Markets, and1. Financial Markets, and

2. Financial 2. Financial Intermediaries.Intermediaries.

1.1.Financial MarketsFinancial Markets

Financial Markets Are Financial Markets Are the (Financial) the (Financial)

Institutions Through Institutions Through Which Savers Can Which Savers Can

Directly Provide Funds Directly Provide Funds to Borrows.to Borrows.

The Two Most The Two Most Important Financial Important Financial Markets in the U.S. Markets in the U.S.

Economy Are the Bond Economy Are the Bond Market and the Stock Market and the Stock

Market.Market.

A Bond-A Bond-

Is a Certificate of Is a Certificate of Indebtedness That Indebtedness That

Specifies the Specifies the Obligations of the Obligations of the Borrower To the Borrower To the

Holder of the Bond.Holder of the Bond.

In Simplest Terms A In Simplest Terms A Bond Can Be Bond Can Be

Considered A Loan. Considered A Loan.

It is Usually Issued by It is Usually Issued by Either a Corporation or Either a Corporation or

The Government.The Government.

Bonds:Bonds:

Because They Are A Loan Because They Are A Loan (or IOU) They “Usually” (or IOU) They “Usually”

Do Not Include Do Not Include Ownership or a Right to Ownership or a Right to

Share in Growth or Share in Growth or Profits. However, Some Profits. However, Some Are Convertible to Stock Are Convertible to Stock or May Include Options or May Include Options

To Convert.To Convert.

Bonds Usually Have A Bonds Usually Have A Date of Maturity and a Date of Maturity and a

Rate of Interest. Rate of Interest. However This May However This May

Take A Wide Variety of Take A Wide Variety of Forms.Forms.

For Example:For Example:

Bonds May Be Paid Off Early Bonds May Be Paid Off Early If The Issuer Exercises A If The Issuer Exercises A

Previously Included Option .Previously Included Option .

They May Not Even Pay They May Not Even Pay Interest But Simply Interest But Simply

Discount the Face Amount Discount the Face Amount of the Bond.of the Bond.

Some Corporate Bonds Some Corporate Bonds May Be Issued With May Be Issued With Options to Purchase Options to Purchase

Shares of Stock at a Set Shares of Stock at a Set Price, or They May Be Price, or They May Be

Convertible Into Shares Convertible Into Shares of Common or Preferred of Common or Preferred

Stock.Stock.

Bonds Are Rated Bonds Are Rated According to Their According to Their

Credit Risk.Credit Risk. Government Bonds Are Government Bonds Are Considered Less Risky Considered Less Risky and Therefore Usually and Therefore Usually Pay a Lower Interest.Pay a Lower Interest.

Government Bonds-Government Bonds-

May Be Issued By May Be Issued By Federal, State or Local Federal, State or Local Governments and May Governments and May Also Have Any Interest Also Have Any Interest

Paid as Being Tax Paid as Being Tax Exempt.Exempt.

Important Note:Important Note:

Bonds May Go Into Bonds May Go Into Default, Wherein the Default, Wherein the Owner May Get Either Owner May Get Either a Partial Payment or a Partial Payment or

NothingNothing..

The Second Type of The Second Type of Financial Market is Financial Market is

Called the Stock Called the Stock Market.Market.

StockStock

Represents Partial Represents Partial Ownership in a Company Ownership in a Company

and Therefore Has a Claim and Therefore Has a Claim to the Profits The Company to the Profits The Company

Makes or a Share of the Makes or a Share of the Proceeds When and If the Proceeds When and If the

Company is Sold.Company is Sold.

The Sale of Stock to The Sale of Stock to Raise Money is Called Raise Money is Called Equity FinanceEquity Finance..

The Sale of a Bond to The Sale of a Bond to Raise Money is Called Raise Money is Called Debt FinanceDebt Finance..

Shares of StockShares of Stock

May Be Sold Through May Be Sold Through Either a Private Offering Either a Private Offering

(Limited).(Limited).

Or a Public Offering and Or a Public Offering and Traded on One of the Traded on One of the

Many Exchanges.Many Exchanges.

Stock PricesStock Prices

The Price of A Share of The Price of A Share of Stock is Determined Stock is Determined

By Supply and By Supply and Demand. It is Demand. It is Influenced By Influenced By

Expectations, Profits Expectations, Profits and the Overall and the Overall

Economy.Economy.

Bonds Vs. StocksBonds Vs. Stocks

Bonds Usually Are Paid Bonds Usually Are Paid Interest Plus a Return of the Interest Plus a Return of the Face Amount of the Bond.Face Amount of the Bond.

Stock Prices Vary As Does Stock Prices Vary As Does the Company’s Profits And the Company’s Profits And the Market. There is No the Market. There is No Guarantee of A Return of Guarantee of A Return of Investment.Investment.

2. Financial 2. Financial IntermediariesIntermediaries

The Second Category Besides The Second Category Besides Financial Markets is Called Financial Markets is Called

Financial IntermediariesFinancial Intermediaries That That Are Financial Institutions Are Financial Institutions

Through Which Savers Can Through Which Savers Can Indirectly Provide Funds to Indirectly Provide Funds to

Borrowers.Borrowers.

Financial Financial IntermediariesIntermediaries

Two of the Most Two of the Most Important Financial Important Financial Intermediaries Are Intermediaries Are Banks and Mutual Banks and Mutual

Funds.Funds.

Other Financial Other Financial IntermediariesIntermediaries

Savings Banks.Savings Banks.Savings and Loan.Savings and Loan.Life-Insurance-Companies.Life-Insurance-Companies.Pension Funds.Pension Funds.Money Market Funds.Money Market Funds.Credit Unions.Credit Unions.

BanksBanks

Banks Are Financial Banks Are Financial Intermediaries Who Take Intermediaries Who Take

Deposits From People who Deposits From People who Want to Save and Use These Want to Save and Use These Deposits to Make Loans to Deposits to Make Loans to

People who Want to Borrow.People who Want to Borrow.

Banks-Banks-

Take the Savers Deposits Take the Savers Deposits and Pay Them an Interest and Pay Them an Interest

and Then Charge the and Then Charge the Borrowers A Higher Borrowers A Higher

Interest on Their Loans.Interest on Their Loans.

Banks Also Facilitate Banks Also Facilitate Trading By Trading By

Establishing a Medium Establishing a Medium of Exchange By of Exchange By Making Money Making Money

Available.Available.

A Mutual FundA Mutual Fund

Is an Institution That Is an Institution That Sells Shares to the Public Sells Shares to the Public and Uses the Proceeds to and Uses the Proceeds to

Buy a Selection, or Buy a Selection, or Portfolio, of Various Portfolio, of Various

Types of Stocks, Bonds, Types of Stocks, Bonds, or Both Stocks and or Both Stocks and

Bonds.Bonds.

The Shareholder of a The Shareholder of a Mutual Fund Accepts the Mutual Fund Accepts the

Risks and Returns Risks and Returns Associated With the Associated With the

Portfolio. Like Common Portfolio. Like Common Stock the Shareholder Stock the Shareholder

Benefits When the Value Benefits When the Value Increases and Suffers a Increases and Suffers a

Loss When the Value Loss When the Value Decreases.Decreases.

Two Advantages of Two Advantages of Mutual Funds Over Mutual Funds Over

Common StockCommon Stock1.1. Diversification- Mutual Funds Diversification- Mutual Funds

Typically Have a Variety of Typically Have a Variety of Stocks in Their Portfolio.Stocks in Their Portfolio.

2.2. They are Managed By They are Managed By Professionals Who Are Experts Professionals Who Are Experts in Their Field and Able to in Their Field and Able to Concentrate Their Efforts.Concentrate Their Efforts.

Mutual Funds Also Mutual Funds Also Allow a Small Investor Allow a Small Investor

to Buy a Number of to Buy a Number of Different Stocks That Different Stocks That They May Otherwise They May Otherwise

Not Be Able to AffordNot Be Able to Afford..

Let Us Again Look At Let Us Again Look At Our Formula For The Our Formula For The GDP That Included GDP That Included

Both The Total Income Both The Total Income and Expenditures and Expenditures

Within the Borders of Within the Borders of The United States.The United States.

You Will (I Hope) You Will (I Hope) Remember That:Remember That:

GDP (Y) = GDP (Y) = Consumption (C) + Consumption (C) + Investment (I) + Investment (I) +

Government (G) + Net Government (G) + Net Export (NX)Export (NX)

Now Let Us Say (For Now Let Us Say (For Current Purposes) That Current Purposes) That We Have a Completely We Have a Completely Closed Economy Where Closed Economy Where There Are No Exports or There Are No Exports or

Imports. We Know This Is Imports. We Know This Is Not Realistic But Humor Not Realistic But Humor

Me.Me.

From Your High School From Your High School Math Days You Will Math Days You Will

Remember That This Remember That This Can Be Changed To Can Be Changed To

Read:Read:

I = Y – C – GI = Y – C – G

In Other Words I = Y – C – G In Other Words I = Y – C – G Means the Income That is Means the Income That is

Left After Paying for Left After Paying for Consumption and Consumption and

Government Purchases. This Government Purchases. This Amount is Called National Amount is Called National

Savings (or Savings) and Is Savings (or Savings) and Is Denoted as S. Therefore, S=I Denoted as S. Therefore, S=I

Or Savings Equals Or Savings Equals Investment.Investment.

National SavingNational Saving

The Total Income In The Total Income In the Economy That the Economy That

Remains After Paying Remains After Paying for Consumption and for Consumption and

Government Government Purchases.Purchases.

Let Us Now Let T Denote Let Us Now Let T Denote the Amount the the Amount the

Government Collects Government Collects From Households in From Households in

Taxes Minus the Amount Taxes Minus the Amount It Pays Back to It Pays Back to

Households in the Form Households in the Form of Transfer Payments.of Transfer Payments.

Note:Note:

This is Necessary Because As This is Necessary Because As You Will Recall Transfer You Will Recall Transfer

Payments Are Not Included Payments Are Not Included In the GDP and Therefore We In the GDP and Therefore We

Must Account For Them In Must Account For Them In the Amount the Government the Amount the Government

Collects in Taxes.Collects in Taxes.

We Can Now Rewrite Our We Can Now Rewrite Our Equation as:Equation as:

S = (Y – T – C) + (T – G)S = (Y – T – C) + (T – G)

This Equation Separates This Equation Separates National Savings Into Two National Savings Into Two

Pieces:Pieces:Private Savings (Y – T – C) Private Savings (Y – T – C)

andandPublic Savings (T – G)Public Savings (T – G)

Private SavingPrivate SavingY – T – C Y – T – C

The Income That The Income That Households Have Left Households Have Left After Paying for Taxes After Paying for Taxes

and Consumption.and Consumption.

Public SavingPublic SavingT – G T – G

The Tax Revenue That The Tax Revenue That The Government Has The Government Has Left After Paying For Left After Paying For

Its Spending.Its Spending.

Budget SurplusBudget Surplus

An Excess of Tax An Excess of Tax Revenue Over Revenue Over

Government Spending.Government Spending.

Budget DeficitBudget Deficit

A Shortfall of Tax A Shortfall of Tax Revenue From Revenue From

Government Spending.Government Spending.

Please Pay Please Pay Attention:Attention:

as This May Be as This May Be Hard to Grasp.Hard to Grasp.

Important Note:Important Note:

Although in the Although in the Accounting Savings = Accounting Savings =

Investment For a Investment For a Nation, That Does Not Nation, That Does Not Have to Be True For an Have to Be True For an

Individual.Individual.

Example:Example:

If you Earn More Than You If you Earn More Than You Spend On Consumption and Put Spend On Consumption and Put Your Money in a Bank or Some Your Money in a Bank or Some

Other Vehicle Such as Stocks or Other Vehicle Such as Stocks or Bonds Hoping to Get a Return Bonds Hoping to Get a Return on Your Money. You Are NOT on Your Money. You Are NOT “Investing” as Defined By the “Investing” as Defined By the

GDP as You Are Not Buying GDP as You Are Not Buying Buildings or Equipment.Buildings or Equipment.

How Does Savings = How Does Savings = Investment?Investment?

The Saving = Investment The Saving = Investment Comes in Where The Comes in Where The

Bank or Proceeds From Bank or Proceeds From the Stocks or Bonds May the Stocks or Bonds May Go to Buy Buildings and Go to Buy Buildings and

Equipment.Equipment.

In Short:In Short:

Macroeconomists Are Macroeconomists Are Stealing the Word Stealing the Word

“Investment” From “Investment” From What You and I Use it What You and I Use it For and Changing The For and Changing The

Meaning.Meaning.

Market for Loanable Market for Loanable FundsFunds

The Market in Which The Market in Which Those Who Want to Those Who Want to Save Supply Funds Save Supply Funds

and Those Who Want and Those Who Want to Borrow to Invest to Borrow to Invest

Demand Funds.Demand Funds.

The Market For Loanable The Market For Loanable Funds:Funds:

For Simplicity, If We Say For Simplicity, If We Say That the Economy Has That the Economy Has

Only One Financial Only One Financial Market for Savers and Market for Savers and Borrowers to go to; to Borrowers to go to; to Either Deposit Funds or Either Deposit Funds or

Get Loans.Get Loans.

Of Course This is Not Of Course This is Not True as There Are True as There Are

Many Different Many Different Markets As We Have Markets As We Have Just Seen, Such as; Just Seen, Such as;

Banks, Stocks, Bonds, Banks, Stocks, Bonds, Mutual Funds, Etc.Mutual Funds, Etc.

The Term The Term Loanable Loanable FundsFunds Refers to All Refers to All Income That People Income That People

Have Chosen to Save Have Chosen to Save and Lend Out; Rather and Lend Out; Rather

Than Use for Their Than Use for Their Own Consumption.Own Consumption.

In the Market of In the Market of Loanable Funds There Loanable Funds There is Only One Interest is Only One Interest Rate, Which Is Both Rate, Which Is Both

The Return to Savings The Return to Savings and The Cost of and The Cost of

Borrowing.Borrowing.

Interest

Rate

Loanable Funds

(In Billions of Dollars)

0 $1,200

5%

----

----

----

----

----

----

Market For Loanable Funds

Supply

Demand

Savings Is the Savings Is the Source Of The Source Of The

SupplySupply of Loanable of Loanable Funds.Funds.

Investment is the Investment is the Source of the Source of the DemandDemand For For

Loanable Funds.Loanable Funds.

A Higher Interest Rate A Higher Interest Rate Would Encourage Saving Would Encourage Saving (Thereby Increasing the (Thereby Increasing the

Quantity of Loanable Funds Quantity of Loanable Funds SuppliedSupplied) and Discourage ) and Discourage Borrowing For Investment Borrowing For Investment (Thereby Decreasing the (Thereby Decreasing the

Quantity of Loanable Funds Quantity of Loanable Funds DemandedDemanded).).

Likewise a Lower Interest Likewise a Lower Interest Rate Would Discourage Rate Would Discourage

Saving (Thereby Decreasing Saving (Thereby Decreasing the Quantity of Loanable the Quantity of Loanable

Funds Funds SuppliedSupplied) and ) and Encourage Borrowing For Encourage Borrowing For

Investment (Thereby Investment (Thereby Increasing the Quantity of Increasing the Quantity of

Loanable Funds Loanable Funds DemandedDemanded).).

Interest

Rate

Loanable Funds

(In Billions of Dollars)

0 $1,200

5% --------------------------

----

----

----

----

----

----

Market For Loanable Funds

Supply

Demand

Surplus

Shortage

Problem?Problem?

The United States Has The United States Has a Lower Saving Rate a Lower Saving Rate

Than Many of the Than Many of the Other Nations In the Other Nations In the

World.World.

In 1999 Percentage of In 1999 Percentage of GDP Saved: (Source GDP Saved: (Source McConnell)McConnell)CountryCountry SavedSavedIndia 20%India 20%ChinaChina 42 42Japan Japan 30 30GermanyGermany 23 23United States 15United States 15

Note:Note:

Many Very Poor Countries Many Very Poor Countries Such as Chad, Ghana, Such as Chad, Ghana,

Madagascar and Uganda Madagascar and Uganda Have a Negative Savings Have a Negative Savings

Rate or in the 0-6% Range Rate or in the 0-6% Range as the People Are to Poor to as the People Are to Poor to

Save.Save.

So What If Anything So What If Anything Should or Can a Should or Can a

Government Do to Government Do to Affect the Savings Affect the Savings Rate of the United Rate of the United

States.States.

First :First :

The Government Can The Government Can Reform its Tax Laws to Reform its Tax Laws to

Encourage Greater Encourage Greater Savings, The Result Savings, The Result

Would Be Lower Interest Would Be Lower Interest Rates and Greater Rates and Greater

Investment.Investment.

Policy 1: Savings Policy 1: Savings IncentivesIncentives

If the Government Allows If the Government Allows a Person to Shelter Some a Person to Shelter Some

of Their Saving From of Their Saving From Taxation.Taxation.

Example: IRA, Bonds.Example: IRA, Bonds.

Tax IncentivesTax Incentives1.1. Tax Incentives For Savings Tax Incentives For Savings

Increase the Supply of Loanable Increase the Supply of Loanable Funds.Funds.

2.2. The Increase in the Supply of The Increase in the Supply of Loanable Funds, Reduces the Loanable Funds, Reduces the Equilibrium Interest Rate.Equilibrium Interest Rate.

3.3. The Increase in the Supply of The Increase in the Supply of Loanable Funds, Raises the Loanable Funds, Raises the Equilibrium Quantity of Equilibrium Quantity of Loanable Funds.Loanable Funds.

Interest

Rate

Loanable Funds

(In Billions of Dollars)

0 $1,200

5% --------------------------

----

----

----

----

----

----

Market For Loanable Funds Suppl

y

S1

Demand

Supply

S2

$1,600

4%

----

----

----

----

-------------------------------------

Policy 2: Investment Policy 2: Investment IncentivesIncentives

Investment Tax Credit Investment Tax Credit Gives a Tax Advantage Gives a Tax Advantage to Any Firm Building a to Any Firm Building a

Factory or Buying a Factory or Buying a New Piece of New Piece of Equipment.Equipment.

If a Reform of the Tax Laws If a Reform of the Tax Laws Encouraged Greater Encouraged Greater

Investment, Through a Investment, Through a Vehicle Such as An Vehicle Such as An

Investment Tax Credit, The Investment Tax Credit, The Result Would Be Higher Result Would Be Higher

Interest Rates and Greater Interest Rates and Greater Savings.Savings.

An Investment Tax An Investment Tax CreditCredit

1. An Investment Tax Credit 1. An Investment Tax Credit Increases the Demand For Increases the Demand For Loanable Funds.Loanable Funds.

2. An Increased Demand for 2. An Increased Demand for Loanable Funds Raises the Loanable Funds Raises the Equilibrium Interest RateEquilibrium Interest Rate

3. An Increased Demand for 3. An Increased Demand for Loanable Funds Raises the Loanable Funds Raises the Equilibrium Quantity of Loanable Equilibrium Quantity of Loanable Funds.Funds.

Interest

Rate

Loanable Funds

(In Billions of Dollars)

0 $1,200

5% --------------------------

----

----

----

----

----

----

Market For Loanable Funds

Supply

D1 Demand

$1,400

6% ---------------------------------

----

----

----

----

----

----

----

----

D2 Demand

Policy 3: Government Policy 3: Government Budget Deficits and Budget Deficits and

Surpluses.Surpluses.

Governments Finance Governments Finance Budget Deficits By Budget Deficits By

Borrowing in the Bond Borrowing in the Bond Market, and the Market, and the

Accumulation of Past Accumulation of Past Government Borrowing is Government Borrowing is Called Government Debt.Called Government Debt.

A Government Budget A Government Budget DeficitDeficit

1. 1. A Budget Deficit Decreases the A Budget Deficit Decreases the Supply of Loanable Funds.Supply of Loanable Funds.

2.2. The Decrease in Loanable The Decrease in Loanable Funds Raises the Equilibrium Funds Raises the Equilibrium Interest Rate.Interest Rate.

3.3. The Decrease in Loanable The Decrease in Loanable Funds Reduces the Equilibrium Funds Reduces the Equilibrium Quantity of Loanable Funds.Quantity of Loanable Funds.

Interest

Rate

Loanable Funds

(In Billions of Dollars)

0 $1,200

5% --------------------------

----

----

----

----

----

----

Market For Loanable Funds

S1 Supply

D1 Demand

S2 Supply

$800

6% -----------------

----

----

----

----

----

----

----

---

Figure 5 The U.S. Government Figure 5 The U.S. Government DebtDebt

Percentof GDP

1790 1810 1830 1850 1870 1890 1910 1930 1950 1970 1990

RevolutionaryWar

2010

CivilWar World War I

World War II

0

20

40

60

80

100

120

QuestionsQuestions

??

Quick WriteQuick Write

If You Were President If You Were President of the United States, of the United States, What Would You Do What Would You Do About the Savings About the Savings

Problem In the U.S.?Problem In the U.S.?