Saving, Investment, and the Financial System

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Chapter 13

• Saving, Investment, and the Financial System

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Outline

• Coordination of savings and investment by the
  economy
• Working of the financial system and its
  constitution
• Develop a model of supply and demand for funds
• Impact of government policies on interest rate

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Financial System in Canada

• Financial system is a group of institutions in
  the economy that help to match one persons
  saving with another persons investment.
• It is made up of a number of financial
  institutions. Broadly of two types
• Financial markets
• Financial Intermediaries

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Financial Markets

• Financial markets are institutions through which
  savers can directly provide funds to borrowers
• The bond market
• The stock market
• The bond is a certificate of indebtedness and has
  two important characteristics
• Term of the bond (date of maturity)
• Credit risk- probability of default by the
  borrower
• Tax assessment Interest rate on most bonds is
  subject to a tax

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Financial Markets

• 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
• Equity finance versus debt finance
• The prices at which shares trade on stock
  exchange are determined by the supply and demand
  for the stock in the company
• Equity premium- bonus paid by the market to
  shareholders
• Stock index is the average of a group of stock
  prices

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Financial Intermediaries

• Financial intermediaries are financial
  institutions through which savers ca indirectly
  provide funds to borrowers
• Banks
• Mutual funds
• Banks help create a special asset (cheques
  against deposits) that functions as a medium of
  exchange

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Financial Intermediaries

• Mutual fund is an institution that sells shares
  to the public and uses the proceeds to buy a
  portfolio of stocks and bonds
• The shareholder of the mutual fund accepts the
  risks and returns associated with the mutual fund
• Helps small savers to diversify risk

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Reading the Newspapers stock tables
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Reading an online Quote
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S and I in the National Income Accounts

• S and I are important determinants of LR growth
  in GDP and standards of living of a nation
• Recall Y C I G NX
• Assume a closed economy
• There are two components to national saving
• Public saving
• Private saving

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S and I in the National Income Accounts

• For the economy as a whole, saving must be equal
  to investment
• The concept and calculation of Present Value

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The Market For Loanable Funds

• Financial markets co-ordinate the economys
  saving and investment in the Loanable Funds
  Market
• Saving represents the supply of loanable funds
• Investment represents demand for loanable funds
• The supply and demand for loanable funds depends
  on the real interest rate
• Equilibrium determines the real interest rate in
  the economy

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Government Policy and Economys Saving and
Investment

• Policies that influence the loanable funds
  market
• Tax incentives and Saving
• Tax incentives that encourage savings would
  result in lower interest rates and greater
  investment
• Tax credits and Investment
• Tax credits that encourage investment would
  result in higher interest rates and greater
  saving
• Government Budget Deficits/Surpluses

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Government Policy and Economys Saving and
Investment

• Government Budget Deficits
• Impacts adversely on national saving
• Government borrowing crowds out private
  investment
• Budget deficits and vicious circle
• Budget surplus and virtuous circle
• Accumulation of government debt in Canada
• Policies undertaken by the federal and provincial
  governments

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FEDERAL GOVT BUDGET SURPLUS and BUDGET DEFICIT
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PROVINCIAL GOVT BUDGET SURPLUS and BUDGET DEFICIT
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Savings and Investment in Canada as of GDP
1961-2001