chapter 3 Flashcards
(21 cards)
what are savers and saving?
income that is not spent on consumption goods
what are borrowers and investment?
spending by businesses on capital goods
what is the macro fundamental indentity in a closed market?
- domestic income = domestic expenditure
Y=C+G+I+NX - domestic saving (s)=Y-C-G
So Macro fundamental identity in a closed economy is:
S=I
In a closed economy hou can you decompose domestic saving and investment between private and public?
- S = S_priv + S_gov
- I = I_priv + I_gov
- Taxes net of transfers (T) = (T_d + T_i +SS) – (Trf_g + Z_f + Int.PD)
- Private domestic saving (S_priv) = (Y – T) – C
- Budget balance (BB) = T – G – I_gov
then
S_priv+BB=I_priv
Or if
-S_gov= T-G
then,
S_priv + S_gov=I_priv + I_gov
What is the macrofundamental identity in an open economy?
Y-C-G=I+NX
Flows to/from the RoW
- Net exports (= exports - imports)
- Net receipts of factor income (NRFI): inflows of income obtaines from the RoW - outflows of income to the RoW
- Net current transfers (Trf_x): inflows of transfers from the RoW - outflows of transfers to the RoW
…
S = I + CA
what is domestic income and national disposable income?
gross domestic product → corresponds to the income generated by production that occurred in the country
gross national disposable income (Y_d)→ corresponds to all resources available to consume or save (produced by or otherwise made available to the residents of the country in the corresponding period)
Y_d = GDP + NRFI + Trf_X = GNP + Trf_X
A country may invest more than itds domestic saving. How?
- using some saving from the RoW (i.e. current account deficits)
problem: it is not possible to have excessive deficits indefinitely, as external debt may become unsustainable
How can you decompose domestic saving between private and public? What is the twin deficits hypothesis?
- S_priv + BB = I_priv + CA
twin deficits hypothesis → If private saving (S_priv) and private investment (I_priv) are strongly correlated, then the budget balance (BB) and the current account (CA) will also strongly comove
Explain the balance of payments
- current account
→ balance of goods and services (= net exports=NX)
→ primary income account (=net receipts of factor income from abroad = NRFI)
→ secondary income account (= net current transfers from abroad= Trf_X) - capital account
→ net capitala transfers from abroad = KTrf_X (not available for consumption, so not part of disposable income)
current and capital account (CKA) = net lending (+) / net borrowing (-)
- financial account (FA) (how net lending is invested abroad and how net borrowing is sourced from abroad)
→ direct investment (equity+loans)
→ portofolio investment (shares+bonds)
→ financial derivatives
→ reserve assets
The FA is like the mirror image of the CKA
→ higher CKA surplus (deficit) implies more financial outflows (inflows), i.e. more (less) investment abroad - BP=CKA-FA
FA = CKA = Δ Net IIP
→ If CKA (FA) is positive, the net international investment position (IIP) of the country increases (if the country is a net debtor, its net financial liabilities (debt) decrease)
→ If CKA (FA) is negative, the net international investment position (IIP) of the country decreases (if the country is a net debtor, its net financial liabilities (debt) increase)
what are financial institutions?
firms that operate on both sides of the financial markets: borrower in one market and lender in another
- commercial banks
- government-sponsored mortgage lenders
- mutual funds
- pension funds
- insurance companies
- central bank
what is interest rate?
the price of mo0eny over time
- active interest rate → charged on banks loans to costumers (banks assets)
- passive interest rate → paid on banks deposits (banks liabilities)
There are many different interest rates.
usually depends on:
- credit quality of the borrower (rating)
- time maturity of the loan/bond
- size of the loan/bond
Explain the relation between the asset price and the interest rate
- the interest rate on a financial asset is the interest received expressed as a percentage of the asset price
- if the asset price increases, the interest rate decreases
what is the loanable funds market?
the market for loanable funds determines the real interest rate, the quantity of funds loanes (=saving =investment)
- is global, not national
explain the demand for loanable funds (DLF) and what can shift it
- business investment is the main item that makes up the demand for loanable funds
- the higher the real interest rate, the lower is the quatity of loanable funds demanded
What can shift the DLF curve?
- expected profits (→)
explain the supply for loanable funds (SLF) and what can shift it
- saving is the main item that makes up the supply of loanable funds
- the higher the interest rate, the higher is the quantity of loanable funds supplied
What can shift the SLF curve?
- Disposable income (→)
- Expected future income (←)
- Wealth (←)
- Default risk (←)
explain the loanable funds market equilibrium
real interest rate at which the quantity of loanable funds demandaded equals the quantity of loanable funds supplied
- financial markets are highly volatile in the short run. Volatility comes from fluctuations in demand or supply of loanable funds
- these fluctuations affect the real interest rate and the equilibrium quantity of funds lent and borrowed. they also affect asset prices
explain what happens if there was an increase in demand for loanable funds
- an increase in expected profits increases the demand for funds today (planned investment increases)
- there is a shortage of funds
- the real interest rate rises
- as borrowers compete for funds, the interest rises and the supply of funds increases (along the curve)
- quantity of loanable funds increases
- both saving and investment increase
explain what happens if there was an increase in supply for loanable funds
- if one of the influences on saving plans changes and saving increases, the supply of funds increases (more savers willing to lend)
→ higher disposable income
→ lower future income or wealth
→ lower default risk - the real interest rate falls
→ borrowers find it easier to get funds and lenders are unable to lend all the funds they have available → the real interest rate falls as lenders compete to attract borrowers, until supply equals demand
why is the loanable funds market is global, not national?
- if financial capital is mobile: lenders are free to seek the highest real interest rate and borrowers are free to seek the lowest real interest rate
- without capital controls, the loanable funds market would be a single, integrated, global market
→ funds would flow into the coutry in which the interest rate is highest and out of the country in which the interest rate is lowest
→ when funds leave the country with the lowest interest rate, a shortage of funds raises the real interest rate. when funds move into the country with the highest interest rate, a surplus of funds lowers the real interest rate - the free international mobility of financial capital pulls real interest rates around the world toward equality, excepts for differences that reflect differences in the risk premium
what happens if the world interest rate is lower than what it would have been in the domestic market?
- international borrower
S < I → CA < 0
what happens if the world interest rate is higher than what it would have been in the domestic market?
- international lender
S > I → CA > 0
