Matching up Savings and Investment Spending Chapter 9-1

Matching Up Savings and Investment  According to the savings – investment spending identity, savings and investment spending are always equal for the economy as a whole.

Two Sources of Saving 1. Domestic Saving 2. Foreign Saving

S PRIVATE =GDP+TR-T-C S GOVERNMEN =T-TR-G NS= S PRIVAT + S GOVERNME NS=(GDP+TR-T-C)+(T-TR-G)NS=GDP-C-G Closed Economy Algebra GDP = C + I + G I = GDP - C - G I = NS

Investment = National Saving NS= SPRIVAT+ SGOVERNME I = NS Investment spending is equal to private saving plus the budget balance (Government Saving)

Governments Saving / Dissaving  The budget balance is the difference between tax revenue and government spending.  The budget surplus is the difference between tax revenue and government spending when tax revenue exceeds government spending.  The budget deficit is the difference between tax revenue and government spending when government spending exceeds tax revenue.

National Saving NS = S PRIVAT + S GOVERNMENT  National savings, the sum of private savings plus the budget balance, is the total amount of savings generated within the economy.

Closed Economy In a closed economy: GDP = C + I + G S Private = GDP + TR − T − C S Government = T − TR − G NS = S Private + S Government = (GDP + TR − T − C) + (T − TR − G) = GDP − C − G Hence, I = NS Investment spending = National savings in a closed economy

A Budget Surplus

A Budget Deficit

The Savings–Investment Spending Identity in an Open Economy I = S Private + S Government + (IM − X) = NS + KI Investment spending = National savings + Capital inflow in an open economy

Capital Inflow Capital Inflow-Net inflow of funds into a country Capital Inflow Equals Inflow Inflow of Foreign funds minus Outflow Outflow of Domestic funds Capital Inflow can be Negative

The Savings-Investment Spending Identity in Open Economies: the United States, 2003

The Savings-Investment Spending Identity in Open Economies: Japan, 2003

Open Economy Algebra KI = IM - X I = (GDP - C - G) + (IM - X) I = S Private + S Government + (IM − X) I = NS + KI

Inflows Good or Bad? Investment spending eventualy have to be repaid If financed by domestic saving it is repaid into the economy If financed by Capital Inflow it is repaid out of the economy Think back to Chapter 8 There are positive side effects too!

Financial Markets Financial Markets channel the saving of households to business for Investment spending

Market for Loanable funds  The loanable funds market is a hypothetical market that examines the market outcome of the demand for funds generated by borrowers and the supply of funds provided by lenders.  The interest rate is the price, calculated as a percentage of the amount borrowed, charged by the lender to a borrower for the use of their savings for one year.

The Demand for Loanable Funds

Rate of Return The rate of return of a project is the profit earned on the project expressed as a percentage of its cost.

The Supply for Loanable Funds

Equilibrium in the Loanable Funds Market

Savings, Investment Spending, and Government Policy Quantity of private loanable funds demanded falls

Increasing Private Savings