Matching up Savings and Investment

Spending

Chapter 9-1

Matching Up Savings and InvestmentAccording 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

SSPRIVATEPRIVATE=GDP+TR-T-C=GDP+TR-T-C

SSGOVERNMENGOVERNMEN=T-TR-G=T-TR-GNS= SNS= SPRIVATPRIVAT+ S+ SGOVERNMEGOVERNME

NS=(GDP+TR-T-C)+(T-TR-G)NS=(GDP+TR-T-C)+(T-TR-G)

NS=GDP-C-GNS=GDP-C-G

Closed Economy AlgebraGDP = C + I + GI = GDP - C - G

I = NSI = NS

Investment = National Investment = National SavingSaving

NS= SNS= SPRIVATPRIVAT+ S+ SGOVERNMEGOVERNME

I = NSI = NSInvestment spending is equal to private saving plus the budget balance (Government Saving)

Governments Saving / DissavingThe 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 = SNS = SPRIVAT PRIVAT + S+ SGOVERNMENTGOVERNMENT

National savings, the sum of private savings plus the budget balance, is the total amount of savings generated within the economy.

Closed EconomyIn a closed economy: GDP = C + I + G

SPrivate = GDP + TR − T − C

SGovernment = T − TR − G

NS = SPrivate + SGovernment = (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 = SPrivate + SGovernment + (IM − X) = NS + KI

Investment spending = National savings + Capital inflow in an open economy

Capital InflowCapital InflowCapital Inflow-Net inflow of funds into a country

Capital Inflow EqualsEquals

InflowInflow of Foreign funds minusminus

OutflowOutflow 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 - XKI = IM - X

I = (GDP - C - G) + (IM - X)I = (GDP - C - G) + (IM - X)I = SI = SPrivatePrivate + S + SGovernmentGovernment + (IM − X) + (IM − X)

I = NS + KII = NS + KI

Inflows Good or Bad?Investment spending eventualy have to be repaidIf financed by domestic saving it is repaid into the economyIf financed by Capital Inflow it is repaid out of the economyThink 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 fundsThe 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 The Demand for Loanable FundsFunds

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 The Supply for Loanable FundsFunds

Equilibrium in the Loanable Funds Equilibrium in the Loanable Funds MarketMarket

Savings, Investment Savings, Investment Spending, and Government Spending, and Government PolicyPolicy

Quantity of private loanable funds demanded falls

Increasing Private Increasing Private SavingsSavings