Chapters 26 & 27 Twofer Day!!!

Dark side video

Overview / Discussion of saving & investing / Why is it so important / Where does it come from / How much does it cost / LOANABLE FUNDS market graph / CROWDING OUT / 27 SLIDES / Discussion of saving & investing / Why is it so important / Where does it come from / How much does it cost / LOANABLE FUNDS market graph / CROWDING OUT / 27 SLIDES

Why does it all matter? / Last chapter focused on growth / How is that concept connected here? / Why is saving & investing critical? / Last chapter focused on growth / How is that concept connected here? / Why is saving & investing critical?

BUY CAPITAL, BUY CAPITAL / More capital = higher productivity / Higher productivity = higher output / Higher output = more stuff / NOT SPENDING ALL YOUR MONEY IS CRITICAL / FORGOING PRESENT CONSUMPTION ALLOWS US TO INCREASE POTENITAL OUTPUT FOR THE FUTURE / LOOK AT THE GRAPH / More capital = higher productivity / Higher productivity = higher output / Higher output = more stuff / NOT SPENDING ALL YOUR MONEY IS CRITICAL / FORGOING PRESENT CONSUMPTION ALLOWS US TO INCREASE POTENITAL OUTPUT FOR THE FUTURE / LOOK AT THE GRAPH

Need to not spend…it all / Is GDP hurt? / GDP = C + I + G + X / When we don’t spend, we save / What happens to the leftover money? / Banks loan it to other people who want to borrow / Is GDP hurt? / GDP = C + I + G + X / When we don’t spend, we save / What happens to the leftover money? / Banks loan it to other people who want to borrow

Financial Intermediaries / Think about it as a picture / FINANCIAL SYSTEM allows borrowers to connect w/ those w/ money to lend / FINANCIAL MARKETS involves these transactions / 2 most common: Bond & Stock Markets / Think about it as a picture / FINANCIAL SYSTEM allows borrowers to connect w/ those w/ money to lend / FINANCIAL MARKETS involves these transactions / 2 most common: Bond & Stock Markets

They’re both MARKETS / Governed by individual incentive & supply/demand / Bond Market: essentially a loan to person looking to borrow / Stock Market: part ownership in the endeavor itself / All about capital (money) going back & forth / Governed by individual incentive & supply/demand / Bond Market: essentially a loan to person looking to borrow / Stock Market: part ownership in the endeavor itself / All about capital (money) going back & forth

Reminder / Money & currency are different…how? / MONEY is anything that: / Medium of Exchange: buy & sell stuff / Unit of Account: comparing values / Store of Value: save for later / Financial intermediaries include banks, credit unions, savings & loan institutions, & MUTUAL FUNDS (DIVERSIFICATION) / Money & currency are different…how? / MONEY is anything that: / Medium of Exchange: buy & sell stuff / Unit of Account: comparing values / Store of Value: save for later / Financial intermediaries include banks, credit unions, savings & loan institutions, & MUTUAL FUNDS (DIVERSIFICATION)

Breather

Following Saving / Keeping track of money is important / Accountants do that for a living / NATIONAL INCOME ACCOUNTING involves doing it on a national level / Most common thing to follow is GDP / Keeping track of money is important / Accountants do that for a living / NATIONAL INCOME ACCOUNTING involves doing it on a national level / Most common thing to follow is GDP

CIGX / GDP (or Y) = CIGX / For now we assume a CLOSED ECONOMY / No foreign component (compared to OPEN) / Manipulating yields GDP-C-G=I / Since any money not spent (by us or gov’t) is saved it becomes / S = I / GDP (or Y) = CIGX / For now we assume a CLOSED ECONOMY / No foreign component (compared to OPEN) / Manipulating yields GDP-C-G=I / Since any money not spent (by us or gov’t) is saved it becomes / S = I

Saving = Investing / Doesn’t matter who / PRIVATE SAVING by us / PUBLIC SAVING by gov’t / Results w/ BUDGET SURPLUS as compared to BUDGET DEFICIT / Saving occurs when you don’t spend / Investing occurs when buy capital / NOT THE SAME THING…but are equal to each other / Why? / Doesn’t matter who / PRIVATE SAVING by us / PUBLIC SAVING by gov’t / Results w/ BUDGET SURPLUS as compared to BUDGET DEFICIT / Saving occurs when you don’t spend / Investing occurs when buy capital / NOT THE SAME THING…but are equal to each other / Why?

Creates a New Market / Saving supplies money to be loaned (supply curve) / Investing creates demand to have money (demand curve) / Combine to form the LOANABLE FUNDS MARKET / Saving supplies money to be loaned (supply curve) / Investing creates demand to have money (demand curve) / Combine to form the LOANABLE FUNDS MARKET

Picture it / What happens when supply or demand changes?

S&I are key to future / Absolutely must do it / What helped cause the recession? / DISSAVING rate for years / Gov’t trying to correct that / Absolutely must do it / What helped cause the recession? / DISSAVING rate for years / Gov’t trying to correct that

“Make” us do it / 1. Saving Incentives / Current plan by Obama to match personal saving / 2. Investment Incentives / Currently count half of investment as tax credit / 3. Gov’t Budget Surplus/Deficit / Uhhh ohhh / 1. Saving Incentives / Current plan by Obama to match personal saving / 2. Investment Incentives / Currently count half of investment as tax credit / 3. Gov’t Budget Surplus/Deficit / Uhhh ohhh

What’s their impact on LF? / 1. Increases supply / Lowers IR; more attractive to borrow / 2. Increases demand / Raises IR; less attractive to borrow / 3. Greatly Increases demand / Raises IR; less attractive to borrow / 1. Increases supply / Lowers IR; more attractive to borrow / 2. Increases demand / Raises IR; less attractive to borrow / 3. Greatly Increases demand / Raises IR; less attractive to borrow

Enter the Federal Reserve / Now saving 5% as country / Seems huge, but still low / Balanced by companies not investing / Gov’t borrowing huge amounts / IR should go up / Held down by FED…discount rate at.25% / Now saving 5% as country / Seems huge, but still low / Balanced by companies not investing / Gov’t borrowing huge amounts / IR should go up / Held down by FED…discount rate at.25%

What happens w/o FED? / Gov’t borrowing increases demand / Increases IR / Makes us less likely to borrow/spend / Goal of their spending to increase GDP but doesn’t work / CROWDING OUT / Gov’t borrowing increases demand / Increases IR / Makes us less likely to borrow/spend / Goal of their spending to increase GDP but doesn’t work / CROWDING OUT

In theory it balances / Chart on page 578 / Debt to GDP ratio predicted to drop to 15% by 2012 / Where are we now??? / Chart on page 578 / Debt to GDP ratio predicted to drop to 15% by 2012 / Where are we now???

Breather

What is all of that stuff? / No idea what Chapter 27 actually saying / We are going to focus on the RISK / No idea what Chapter 27 actually saying / We are going to focus on the RISK

Risk is the perpetual bad guy / It does nothing positive / Reduces spending, makes us uncomfortable, eliminates wealth / Nobody wants to lose money / RISK AVERSE / It does nothing positive / Reduces spending, makes us uncomfortable, eliminates wealth / Nobody wants to lose money / RISK AVERSE

Understanding risk / Just like playing the lottery / Risk spreading is very desirable / Add DIVERSIFICATION / Just like playing the lottery / Risk spreading is very desirable / Add DIVERSIFICATION

Case in point / Think about insurance / Why buy insurance (any type)? / Essentially betting that something bad will happen / If you win (& it does) they pay / If you lose, they keep your money / Think about insurance / Why buy insurance (any type)? / Essentially betting that something bad will happen / If you win (& it does) they pay / If you lose, they keep your money

2 problems can arise / 1. Adverse Selection / Those most likely to “win” also most likely to buy insurance / 2. Moral Hazard / Having insurance makes you more likely to use it / Act less safe b/c have insurance / 1. Adverse Selection / Those most likely to “win” also most likely to buy insurance / 2. Moral Hazard / Having insurance makes you more likely to use it / Act less safe b/c have insurance

RECAP / Answer the following: / 1. Why is saving/investing critical? / 2. What is the purpose of financial markets? / 3. Draw the loanable funds graph / 4. Define crowding out / Answer the following: / 1. Why is saving/investing critical? / 2. What is the purpose of financial markets? / 3. Draw the loanable funds graph / 4. Define crowding out