Savings and investment

Foldvary, Econ 1a

Time Preference

• the general preference of people for goods in the present time relative to goods in the future.

• Why: 1) finite life span,

• 2) uncertain future.

The natural rate of interest

• The rate at which goods are discounted into the future constitutes the rate of interest.

• In equilibrium, the natural interest rate makes savings equal to investment.

Loanable funds

• Savings available to borrowers.

• The supply of loanable funds is savings.

• The demand is from borrowers.

• Some borrowing is for consumption.

• Net savings is total savings minus borrowing for consumption.

• Net savings equals investment.

Debt service

• pure interest: real interest.

• inflation premium.

• risk premium (for bad loans)

• fluctuation risk, long-term bonds.

• tax premium

The stock market

• Equity finance. Equities.

• Retained earnings: profits held.

• Double taxation of corporate profit.

• Double taxation increases corporate debt and retained earnings.

Depositors are lenders

• Your deposits become loans to others.

• A check is a loan.

• Paying with a credit card is borrowing.

• The seller pays a fee.

Mutual funds

• A portfolio is a set of assets.

• A mutual fund is a corporation that owns a portfolio of stocks, bonds, and other assets.

• Mutual funds enable diversification and professional financial management.

Government savings

• Governments also save and borrow.

• National savings includes both private and governmental savings.

• Governments with budget deficits have negative savings, or dissavings.

• S = (Y-T-C) + (T-G), private savings plus government savings. T: taxes.

Effect of government borrowing

• Government competes with private enterprise to sell bonds.

• Government borrowing crowds out private borrowing.

• There is less investment, less growth.

• Unless government borrowing is for productive investment.

The structure of capital goods

• The time structure, like a stack of pancakes.

• Higher on the stack: longer held.

• Higher order goods, more responsive to the rate of interest.

• Lower interest rates make the stack taller.

• The creation of money acts like savings,

• but results in wasted investments.