THE CIRCULAR FLOW H&B Y F S T Trsy FxM K CrM Def Cd MD MS E I G PrM Cash Fed FxM S T I G Cd E K Def Y X F MD MS

THE CREDIT MARKET Deficit = Gov’t Purchases + Transfers – Taxes CrM Fed S I K Def MD MS Cash Deficit = Gov’t Purchases + Transfers – Taxes = Amount the gov’t borrows per year K = Foreign Capital = Amount loaned to US by other countries = F – E = Trade Deficit (That is, roughly: The world lends to the US the amount left over after ‘shopping in the US”) MS = the amount of money “printed” by the Federal Reserve

THE CREDIT MARKET THE “IN” ARROWS = LENDING = SUPPLY 1. Saving CrM Fed S I K Def MD MS Cash THE “IN” ARROWS = LENDING = SUPPLY 1. Saving from US Households and Businesses 2. K = Foreign Capital Borrowed from Other Countries 3. MS = Printed by the Fed 4. MD = From Cash THE “OUT” ARROWS = BORROWING = DEMAND 1. Investment Borrowed by US Businesses 2. Def = the Deficit Borrowed by the Government $IN = $OUT Most of these numbers can be positive or negative

THE CREDIT MARKET in SUPPLY and DEMAND To describe a market using Supply and Demand we need to decide: Price What is the price? That will go on the y- axis Supply Demand What is the quantity? That will go on the x -axis What is Demand? What is Supply? Quantity

THE CREDIT MARKET in SUPPLY and DEMAND The price of credit is … the interest rate -- i The quantity of credit is … i the number of dollars loaned and borrowed. We will use “z” We can also put X and AD – both of which mean spending -- on the quantity axis. We can do this because the decision to borrow more is almost always the decision to spend more. Z, X, AD

THE CREDIT MARKET in SUPPLY and DEMAND There is a Demand for Credit. We’ll call it Borrowing. i L the Supply of Lending B the Demand for Borrowing There is a Supply of Credit. We’ll call it Lending. Z, X, AD

THE CREDIT MARKET in SUPPLY and DEMAND And there is equilibrium in the market. Z0 i0 B Z, X, AD

Now we need the curve shifters THE CREDIT MARKET in SUPPLY and DEMAND Fortunately we already have them i L = S + K + Cash + MS There are four Supply/Lending shifters: S, K, Cash and MS These are the arrows in to the Credit Market Z0 i0 B = I + Def Z, X, AD There are two Demand/Borrowing shifters: I and Def These are the arrows out of the Credit Market

MD and Cash mean the same thing THE CREDIT MARKET Credit Demand = Borrowing = “out” arrows Comparing -- i REVISED SLIDE L = S + K + MD + MS S K Z0 i0 Credit Market Def Cash MD I MS Fed B = I + Def Z, X, AD Credit Supply = Lending = “in” arrows MD and Cash mean the same thing

Whether using the Circular Flow or Supply and Demand, equilibrium in the Credit Market requires that: S + K + MS + MD = I + Def