Saving, Investment, and the Financial System

1. Saving, Investment, and the Financial System • The financial system consists of the group of institutions in the economy that help to match one person’s saving with another person’s investment. • It moves the economy’s scarce resources from savers to borrowers.

2. FINANCIAL INSTITUTIONS IN THE U.S. ECONOMY • The financial system is made up of financial institutions that coordinate the actions of savers and borrowers. • Financial institutions can be grouped into two different categories: • Financial markets • Financial intermediaries

3. FINANCIAL INSTITUTIONS IN THE U.S. ECONOMY • Financial Markets • Stock Market • Bond Market • Financial Intermediaries • Banks • Mutual Funds

4. FINANCIAL INSTITUTIONS IN THE U.S. ECONOMY • Financial marketsare the institutions through which savers can directly provide funds to borrowers. • Financial intermediariesare financial institutions through which savers can indirectly provide funds to borrowers.

5. Financial Intermediaries:Banks • Banks take deposits from people who want to save and use the deposits to make loans to people who want to borrow. • Banks pay depositors interest on their deposits and charge borrowers slightly higher interest on their loans.

6. Financial Markets • The Bond Market • A bond is a certificate of indebtedness that specifies obligations of the borrower to the holder of the bond. • Characteristics of a Bond • Term: The length of time until the bond matures. • Credit Risk: The probability that the borrower will fail to pay some of the interest or principal. • Tax Treatment: The way in which the tax laws treat the interest on the bond. • Municipal bonds are federal tax exempt.

7. Bond Prices react to interest rates. • If a bond is paying 10% and interest rates go to 5% is the bonds price going to go up or down? • What if interest rates go to 15% what is that bond going to be worth? • See 2010 Question 2 AP Test. • So if interest rates go up bond prices go down and vice versa.

8. Financial Markets • The Stock Market • Stock represents a claim to partial ownership in a firm and is therefore, a claim to the profits that the firm makes. • The sale of stock to raise money is called equity financing. • Compared to bonds, stocks offer both higher risk and potentially higher returns. • The most important stock exchanges in the United States are the New York Stock Exchange, the American Stock Exchange, and NASDAQ.

9. Banks • Banks help create a medium of exchange by allowing people to write checks against their deposits. • A medium of exchanges is an item that people can easily use to engage in transactions. • This facilitates the purchases of goods and services.

10. National Income Accounts • National saving-the total income in the economy that remains after paying for the consumption and government purchases.

11. Remember that GDP can be divided up into four components: consumption, investment, government purchases, and net exports.

12. National Savings • To make the concept easy pretend we have a closed economy where no trade occurs. • So for our GDP equation it would be • Y=C+I+G

13. National Savings • So Y=C+G+I • To isolate investment, we can subtract C and G from both sides: • Y-C-G=I • Or GDP-Consumption-Government Purchases =Investment • What is left is called national savings. • Savings=Y-C-G=I • Savings =Investing

14. You will have to keep reminding students what the term “investment” means to macroeconomists. Outside of the economics profession, most people use the terms “saving” and “investing” interchangeably. • In macroeconomics, investment refers to the purchase of new capital, such as equipment or buildings. (factories) • If an individual spends less than he earns and uses the rest to buy stocks or mutual funds, economists call this saving.

15. Definition of National Saving (Saving): the total income in the economy that remains after paying for consumption and government purchases

16. Saving Continued • Savings=GDP-Consumption-Govt Spending • If T= Taxes and Transfer payments back to SS and Welfare It can be broken down also like this S=(Y-T-C) + (T-G) This breaks down into private savings and public savings

17. Private Saving: the income that households have left after paying for taxes and consumption. • Public Saving: the tax revenue that the government has left after paying for its spending. • Budget Surplus: an excess of tax revenue over government spending. • Budget Deficit: a shortfall of tax revenue from government spending.

18. Breaking down National Savings NS=(Y-T-C) + (T-G) Public Savings Private Savings Public Savings-is the amount of tax revenue that the government has left after paying for it spending • Private Savings-is the amount of income that households have left after paying their taxes and paying for their consumption

19. Types of Savings • Budget surplus-If govt receives more then they pay out. T-G is positive

20. Types of Savings • Budget Deficit T-G is negative

21. The important point to make here is that with a government budget deficit, public saving is negative and the public sector is thus “dissaving.” To make up for this shortfall, it must go to the loanable funds market and borrow the money. This will reduce the supply of loanable funds available for investment.

22. New Stuff

23. Is There A Social Cost To Extended Unemployment?

24. Is There A Social Cost To Extended Unemployment? Here Is What Happens. With pressure from bill collectors (and his wife), he holds up an ATM called Kenny and shoots it. Then, after many rejections, he becomes a reluctant discouraged worker. At first the job seeker optimistically looks for his next job.

25. Then What? And – the Texas Justice System will tell him to, “Take that.” And his kids will cry because they can no longer go to college. Eventually he is caught and incarcerated.

26. Crime rates move with the business cycle…rising during periods of high unemployment and falling during periods of low unemployment. The crime statistics released in the fall of 1997 bear this out. With unemployment at a 25-year low at 4.9%the rate of violent crime was down for a fifth consecutive year, and the murder rate fell to its lowest level since 1969. FBI crime statistics show that both property crime and violent crime increased sharply between 1985 and 1991 and fell dramatically from 1991 to 1997 in step with unemployment. Social Cost of Unemployment

27. Unemployment and social problems Each one-point increase in theunemployment rate for an extended period is associated with: 920 more suicides 650 more homicides 4000 more people admitted to state mental institutions 3300 more people sent to state prisons 37,000 more deaths increases in domestic violence and homelessness

28. Stress Associated With Joblessness and Other Events Life EventLevel of Stress Death of Spouse 100 Going to jail 66 Fired from job 49 Close friend died 47 Laid off from job 40 Failed school 37 Child left home 29 Major change in 20 working conditions

29. 40 36 32 Adult Males Adult Females Teenagers 28 24.7 24 20 16.7 16 11.4 12 6.4 5.9 8 5.4 5.3 4.0 3.7 3.5 3.5 2.7 3.2 4 1.8 1.6 0.9 0 Black Black White White Black White College College Master's Doctoral Hispanic Hispanic Hispanic National degree degree High school High school average dropouts dropouts graduates graduates Who Were the Unemployed in 2000 when Unemployment was 4%? Unemployment Rates vary by race, sex, age, & education.

30. Unemployment When It Was 4.5% Demographics of Unemployment 1998 – 4.5% Unemployment 27.6% 12.5% 8.9% 8.9% 7.1% 7.2% 3.4% 3.2%

31. 48.0% Unemployment At 10% 2010 - 10%Unempl. In Jan, 2010 as unemployment hit 10%, teenage unemployment hit an all time high of 27%. 27.6% 20.4% 18.9% 17.2% 15.2% 13.9% 12.5% 8.9% 8.9% 9.3% 9.0% 7.2% 7.1% 3.4% 3.2%

32. The More You Learn, The More You Earn 2010 Overall Unemployment Rate = 9.8% [Unemployment Rate & Median Earnings by Education] 16% 14% 12% 10% 8% 7% 6% 5% 4% 3% 2% 1% 0 15.6% $23K Less Than High School Diploma 10.5% $32K High School Grad 8.0% $38K Associates Degree Unemployment Rate - 1998 5.0% $53K College Advanced Degree 3.8% $60K Master’s 3.0% $75K

33. Unemployment - 2007 7.1/153.1 x 100 = Unemployment Rate of 4.6% Under 16 and/or Institutionalized (71.8 Million) Not in Labor Force: Kids, military personnel, retired people, stay at home moms and dads, full-time students, your 35 year old uncle who sleeps on the couch all day, and most of the homeless. Not in Labor Force (78.7 Million) [homemakers, students, retirees] Total Population 303.6 Million) Employed (146 Million) Labor Force (153.1 Million) Unemployed 7.1 mil.

34. Defining/Measuring Unemployment An employed person is any person 16 years old or older: who works for pay, either for someone else or in his or her own business for 1 or more hours per week, who works without pay for 15 or more hours per week in a family enterprise, or who has a job but has been temporarily absent, with or without pay. • An unemployed person is a person 16 years old or older who: • is not working, • is available for work, and • has made specific efforts to find work during the previous 4 weeks. • A person who is not looking for work, either because he or she does not want a job or has given up looking, is not in the labor force. • The discouraged-worker effect lowers the unemployment rate.

35. Survey on Unemployment • BLS calls 60,000 households every month. • [Current Population Survey] • They ask three questions: • Are you working? If the answer is “yes”, • you are member of the labor force. But, • if the answer is no, you get a 2ndquestion. • 2. Did you work at all this month-even 1 day? • If “yes”, you are a member of the LF. But, • if the answer is no, you get a 3rd question. • 3. Did you look for work during the last month? • [agency, resume, interview] A“yes”counts you as • part of the LF. A“no”means you arenot counted. • You are a“discouraged worker.”The labor force • consists of theemployedand unemployed.

36. How is Unemployment Measured? • Natural Rate of Unemployment • The natural rate of unemployment is unemployment that does not go away on its own even in the long run. • It is the amount of unemployment that the economy normally experiences.

37. How Is Unemployment Measured? • Cyclical Unemployment • Cyclical unemployment refers to the year-to-year fluctuations in unemployment around its natural rate. • It is associated with with short-term ups and downs of the business cycle.

38. How Is Unemployment Measured? • Describing Unemployment: Three Basic Questions • How does government measure the economy’s rate of unemployment? • What problems arise in interpreting the unemployment data? • How long are the unemployed typically without work?

39. How Is Unemployment Measured? • Employed vs. unemployed • The BLS considers a person an adult if he or she is over 16 years old. • A person is considered employed if he or she has spent some of the previous week working at a paid job. • A person is unemployed if he or she is on temporary layoff, is looking for a job, or is waiting for the start date of a new job. • A person who fits neither of these categories, such as a full-time student, homemaker, or retiree, is not in the labor force.

40. UNEMPLOYMENT • 3 GROUPS • 1st • UNDER 16 YEARS OLD • Institutionalized or prison don’t count

41. UNEMPLOYMENT • 2nd • Not in labor force- those who could but choose not to work. Like my wife who is staying home with our kids

42. UNEMPLOYMENT • 3rd Labor force • Those who are able and willing to work. • About half the population last year. • GOVT surveys 60k households to determine unemployement

43. How Is Unemployment Measured? • Labor Force • The labor force is the total number of workers, including both the employed and the unemployed. • The BLS defines the labor force as the sum of the employed and the unemployed.

45. Unemployment rate • Unemployed • *100 • Labor Force

46. How Is Unemployment Measured? • The unemployment rate is calculated as the percentage of the labor force that is unemployed.

47. Labor forc e particip ation rate Labor forc e = 100 X Adult popu lation How Is Unemployment Measured? • The labor-force participation rate is the percentage of the adult population that is in the labor force.

48. ALTERNATIVE CLASSROOM EXAMPLE: The country of Bada has collected the following information: Population 240,000 Employed 180,000 Unemployed 30,000 Labor Force = 180,000 + 30,000 = 210.000 Unemployment rate = (30,000/210,000) × 100% = 14.3% Labor-force participation rate = (210,000/240,000) × 100% = 87.5%

49. Employed Labor Force (139.3 million) (147.4 million) Adult Population (223.4 million) Unemployed (8.1 million) Not in labor force (76.0 million) Figure 1 The Breakdown of the Population in 2004

50. Unemployment rate Natural rate of unemployment Figure 2 Unemployment Rate Since 1960 Percent of Labor Force 10 8 6 4 2 0 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005