Saving, Investment, and the Financial System

Graduate School of Management and Economics

Sharif University of Technology

Amineh Mahmoudzadeh
Fall 2023
‫‪Motivation‬‬
‫• به نظر شما نرخ بهره حقیقی در ایران چگونه است و این امر چه تاثیری بر روی پسانداز‬
‫دارد؟‬
‫• منفی‪ -‬کم میکند‬
‫• مثبت – کم میکند‬
‫• منفی‪ -‬باال میبرد‬
‫• مثبت‪ -‬باال میبرد‬

‫‪2‬‬
 Look for the answers to these questions:

• What are the three kinds of saving?

• What’s the difference between saving and investment?
• How does the financial system coordinate saving and
investment?
• How do government policies affect saving, investment, and
the interest rate?
• What are the main types of financial institutions in the U.S.
economy, and what is their function?

3
Accounting Identities

• Gross domestic product (GDP, Y)

▪ Total income = Total expenditure
Y = C + I + G + NX
• Y = gross domestic product, GDP
• C = consumption
• I = investment
• G = government purchases
• NX = net exports

4
Accounting Identities

• Assume closed economy: NX = 0

• Y = C + I + G, so I = Y – C - G
• National saving (saving), S
• Total income in the economy that remains after paying for consumption and government
purchases
o By definition: S = Y – C – G
• It follows: Saving (S) = Investment (I) for a closed economy

5
Accounting Identities

• For T = taxes minus transfer payments

▪ S = Y – C – G can be rewritten as:
▪ S = (Y – T – C) + (T – G)
• Private saving, Y – T – C
▪ Income that households have left after paying for taxes and consumption
• Public saving, T – G
▪ Tax revenue that the government has left after paying for its spending

6
Accounting Identities

• Budget surplus: T – G > 0

▪ Excess of tax revenue over government spending = public saving (T-G)
• Budget deficit: T – G < 0
▪ Shortfall of tax revenue from government spending = – (public saving) = G – T

7
 Active Learning I

8
Active Learning I

A. Suppose GDP equals $10 trillion, consumption equals $6.5 trillion, the
government spends $2 trillion and has a budget deficit of $300 billion.
• Find public saving, net taxes, private saving, national saving, and investment.

B. Use the numbers from the preceding exercise, but suppose now that the
government cuts taxes by $200 billion (How a tax cut affects saving).
In each of the following two scenarios, determine what happens to public saving, private
saving, national saving, and investment.
1. Consumers save the full proceeds of the tax cut.
2. Consumers save 1/4 of the tax cut and spend the other 3/4.

9
Active Learning I (A. Answers)

Given: Y = 10.0, C = 6.5, G = 2.0, G – T = 0.3 (all in trillions)

• Public saving = T – G = – 0.3

• Net taxes: T = G – 0.3 = 1.7
• Private saving = Y–T–C = 10 – 1.7 – 6.5 = 1.8
• National saving S=Y–C–G = 10 – 6.5 – 2 = 1.5
• Investment = national saving = 1.5

10
Active Learning I (B. Answers)

In both scenarios, public saving falls by $200 billion, and the budget deficit
rises from $300 billion to $500 billion.

1. If consumers save the full $200 billion, national saving is unchanged, so

investment is unchanged.
2. If consumers save $50 billion and spend $150 billion, then national saving
and investment each fall by $150 billion.

11
Active Learning I (Discussion Questions)

The two scenarios from this exercise were :

1. Consumers save the full proceeds of the tax cut.
2. Consumers save 1/4 of the tax cut and spend the other 3/4.

• Which of these two scenarios do you think is more realistic?

• Why is this question important?

12
The Meaning of Saving and Investment

• Private saving
▪ Income remaining after households pay their taxes and pay for consumption.
▪ Examples of what households do with saving:
o Buy corporate bonds or equities
o Purchase a certificate of deposit at the bank
o Buy shares of a mutual fund
o Let accumulate in saving or checking accounts

13
The Meaning of Saving and Investment

• Investment
▪ Is the purchase of new capital
▪ Examples of investment:
o General Motors spends $250 million to build a new factory in Flint, Michigan.
o You buy $5000 worth of computer equipment for your business.
o Your parents spend $300,000 to have a new house built.

Investment is NOT the purchase of stocks and bonds!

14
The Market for Loanable Funds

•Loanable funds market

▪A supply–demand model of the financial system
▪Helps us understand:
o How the financial system coordinates saving & investment.
o How government policies and other factors affect saving, investment, the interest rate.

15
The Market for Loanable Funds

• Assume: only one financial market

▪ All savers deposit their saving in this market.
▪ All borrowers take out loans from this market.
▪ There is one interest rate, which is both the return to saving and the cost of borrowing.

16
The Market for Loanable Funds

• The supply of loanable funds comes from saving:

▪ Households with extra income can loan it out and earn interest.
▪ Public saving
o If positive, adds to national saving and the supply of loanable funds.
o If negative, it reduces national saving and the supply of loanable funds.

17
Remember

•As we have been taught

▪ The interest rate (also referred to as the nominal interest rate), i, is the annual cost of a
one-dollar loan, so i × L is the annual cost of an $L loan.
▪ The real interest rate is given by the nominal interest rate minus the inflation rate.
o Real interest rate = Nominal interest rate − Inflation rate.
▪ Optimizing economic agents will use the real interest rate, r, when thinking about the economic cost of
a loan.

18
Borrowers and the Demand for Loans

•Debtors, or borrowers, are economic agents who borrow funds.

•Credit refers to the loans that the debtor receives.

19
The Slope of the Supply Curve

•An increase in the

interest rate makes
saving more
attractive, which
increases the quantity
of loanable funds
supplied.
Shift of the Supply Curve

•Changes in the saving motives of households.

•Changes in the saving motives of firms.

• Changes in the saving motives of households or firms may decrease the quantity of credit
supplied for a fixed level of the real interest rate, shifting the credit supply curve to the left
(panel (a)). When households and firms increase the quantity of credit supplied for a fixed
level of the real interest rate, the credit supply curve shifts to the right (panel (b)).
The Slope of the Supply Curve
The Market for Loanable Funds

• The demand for loanable funds comes from investment:

▪ Firms borrow the funds they need to pay for new equipment, factories, etc.
▪ Households borrow the funds they need to purchase new houses.

23
The Slope of the Demand Curve

•A fall in the interest rate

reduces the cost of borrowing,
which increases the quantity of
loanable funds demanded.

•When the credit demand curve is relatively

steep, the quantity of credit demanded
doesn’t change that much in response to
variation in the real interest rate.
•When the credit demand curve is relatively
flat, the quantity of credit demanded is
relatively sensitive to variation in the real
24
interest rate.
Shift of the Demand Curve

• Changes in perceived business opportunities for firms.

• Changes in household preferences or expectations.
• Changes in government policy.

• Changes in perceived business opportunities for firms, changes in household preferences or

expectations, and changes in government policy may decrease the quantity of credit demanded
for a fixed level of the real interest rate, shifting the credit demand curve to the left (panel (a)).
When they increase the quantity of credit demanded for a fixed level of the real interest rate, the
credit demand curve shifts to the right (panel (b)).
The Slope of the Demand Curve

26
Equilibrium

•The interest rate adjusts to

equate supply and demand.

•The equilibrium quantity of

loanable funds equals
equilibrium investment and
equilibrium saving.

27
Policy 1: Saving Incentives

Interest •Tax incentives for saving

Rate S1 S2 increase the supply of
loanable funds
•…which reduces the
5% equilibrium interest rate
4% •and increases the
equilibrium quantity of
D1
loanable funds
60 70 Loanable Funds
($billions)
28
Policy 2: Investment Incentives

•An investment tax

credit increases the
demand for loanable
funds
•…which raises the
equilibrium interest rate
•and increases the
equilibrium quantity of
loanable funds

29
 Active Learning II (Budget deficits)

30
Active Learning II (Budget deficits)

Use the loanable funds model to analyze the effects of a government budget
deficit:
• Draw the diagram showing the initial equilibrium.
• Determine which curve shifts when the government runs a budget deficit.
• Draw the new curve on your diagram.
• What happens to the equilibrium values of the interest rate and investment?

31
Active Learning II (Budget deficits)

Interest
Rate
S2 •A budget deficit reduces
S1
national saving and the supply
of loanable funds
6% •…which increases the
5% equilibrium interest rate
•and decreases the equilibrium
quantity of loanable funds and
D1 investment.

50 60 Loanable Funds
32 ($billions)
 ‫‪Motivation‬‬
‫• اگر فعالین اقتصادی نسبت به سودآوری فرصت های سرمایه گذاری خوشبین‬
‫گردند‪ ،‬منحنی ‪ ........‬وجوه وام دادنی انتقال می یابد و نرخ بهره تعادلی به‬
‫سمت ‪ ........‬جا به جا می گردد‪.‬‬
‫• الف)عرضه‪-‬باال‬
‫• ب)عرضه‪-‬پایین‬
‫• ج)تقاضا‪-‬باال‬
‫• د)تقاضا‪-‬پایین‬

‫‪33‬‬
Budget Deficits, Crowding Out, and Long-Run Growth

• Our analysis:
▪ Increase in budget deficit causes fall in investment
▪ The government borrows to finance its deficit, leaving less funds available for investment:
crowding out
• Investment is important for long-run economic growth
• Hence, budget deficits reduce the economy’s growth rate and future standard of
living.

34
ASK THE EXPERTS (Fiscal Policy and Saving)

“Sustained tax and spending policies that boost consumption

in ways that reduce the saving rate are likely to lower long-
run living standards.”

35
The U.S. Government Debt

• The government finances deficits by borrowing (selling government bonds).

▪ Persistent deficits lead to a rising government debt.
• The ratio of government debt to GDP
▪ Useful measure of the government’s indebtedness relative to its ability to raise tax
revenue.
▪ Historically, the debt-GDP ratio usually rises during wartime and falls during peacetime—
until the early 1980s.

36
U.S. Government Debt as a Percentage of GDP 1790–2012

37
 ‫شواهد بین المللی ارتباط درآمد سرانه و نرخ سرمایه‌گذاری‬

‫‪100,000‬‬

‫درآمد سرانه سال ‪( 2003‬مقیاس لگاریتمی)‬

‫‪10,000‬‬

‫‪1,000‬‬

‫‪100‬‬
‫‪0‬‬ ‫‪5‬‬ ‫‪10‬‬ ‫‪15‬‬ ‫‪20‬‬ ‫‪25‬‬ ‫‪30‬‬ ‫‪35‬‬
‫سهم سرمایهگذاری از تولید (متوسط ‪)2003-1960‬‬
‫‪38‬‬ ‫‪38‬‬
 ‫رابطه سرمایه‌گذاری و پس‌انداز‬

‫• چرا نرخ سرمایهگذاری کشورها متفاوت است؟‬

‫▪ سرمایهگذاری به قیمت مصرف نکردن حال است‪ .‬پس هر واحد سرمایهگذاری نشانهای از پسانداز است‪ .‬با این حال دلیلی ندارد‬
‫سرمایهگذاری و پسانداز در کشورها با هم برابر باشد‪ ،‬زیرا سرمایهگذاری میتواند از مرز کشورها عبور کند‪.‬‬
‫• بنابراین دو دلیل میتواند سبب متفاوت بودن نرخ سرمایهگذاری باشد‪:‬‬
‫▪ نرخ پس انداز متفاوت‬
‫▪ جریان بینالمللی سرمایهگذاری‬

‫‪39‬‬
 ‫نرخ پس انداز دهک‌های تولید ناخالص داخلی سرانه در کشورهای مختلف‬

‫‪40‬‬ ‫‪40‬‬
 ‫نرخ پس انداز‪ :‬عوامل تعیین کننده برون زا و درون زا‬

‫• برخی از عوامل تعیین کننده موثر بر نرخ پس انداز‪:‬‬

‫▪ سیاستهای دولت‬
‫‪ o‬پس انداز دولتی‪ :‬ایجاد مازاد درآمدها نسبت به هزینههای دولت‬
‫‪ o‬پس انداز عمومی‪:‬‬
‫‪ −‬معرفی صندوقهای بازنشستگی که هر کس مسئول پرداخت برای منافع آتی خود است‪.‬‬
‫‪ −‬تبلیغ‬
‫▪ نابرابری درآمدی‬
‫▪ فرهنگ‬
‫▪ جغرافیا‬
‫▪ درآمد‬

‫‪41‬‬
 ‫اثر درآمد بر پس‌انداز‬

‫• توضیح محتمل کم بودن نرخ پسانداز در کشورهای فقیر‪ ،‬عدم توانایی آنها برای پسانداز است‪.‬‬
‫▪ این استدالل را میتوان برای فقیرترین کشورها پذیرفت‪ ،‬اما در مورد سایر کشورها استدالل محکمی به نظر نمیرسد‪.‬‬

‫• فقیر بودن توجه به آینده را کم میکند‪ .‬بنابراین افراد حاضر به قربانی کردن لذت اکنون برای به دست آوردن لذت آتی نمیشوند‪.‬‬

‫‪42‬‬
Financial Institutions

• Financial system
▪ Group of institutions in the economy that help match the saving of one person with the
investment of another
• Financial institutions
▪ Institutions through which savers can directly provide funds to borrowers
▪ Financial markets
▪ Financial intermediaries

43
Financial Markets

• Financial markets
▪ Savers can directly provide funds to borrowers
▪ The bond market:
o A bond is a certificate of indebtedness
▪ The stock market:
o A stock is a claim to partial ownership in a firm

44
Financial Intermediaries

•Financial intermediaries
▪Financial intermediaries channel funds from suppliers of financial capital to
users of financial capital.
o Institutions through which savers can indirectly provide funds to borrowers
o Banks
o Mutual funds: institutions that sell shares to the public and use the proceeds to buy
portfolios of stocks and bonds

45
46
10
11
unemployment rates: 12

3
4
5
6
7
8
9

01-2007
04-2007
07-2007
10-2007
01-2008
04-2008
U.K.
USA

07-2008
France

Canada
Sweden

10-2008
The Financial Crisis of 2008–2009

01-2009
04-2009
07-2009
10-2009
01-2010
04-2010
07-2010
10-2010
01-2011
04-2011
07-2011
10-2011
01-2012
04-2012
07-2012
10-2012
01-2013
04-2013
07-2013
•A financial crisis led to a deep recession in the U.S. and around the world. A few

10-2013
FYI: Elements of Financial Crises

• Large decline in some asset prices

▪ 2008–2009: Housing prices fell 30%.
• Insolvencies at financial institutions
▪ 2008–2009: Banks and other institutions failed when many homeowners stopped paying
their mortgages.
• Decline in confidence in financial institutions
▪ 2008–2009: Customers with uninsured deposits began pulling their funds out of financial
institutions

47
FYI: Elements of Financial Crises

• Credit crunch
▪ 2008–2009: Borrowers unable to get loans because troubled lenders not confident in
borrowers’ credit-worthiness.
• Economic downturn
▪ 2008–2009: Failing financial institutions and a fall in investment caused GDP to fall and
unemployment to rise.
• Vicious circle
▪ 2008–2009: The downturn reduced profits and asset values, which worsened the crisis.

48
The Anatomy of a Financial Crisis

49
‫‪Motivation‬‬
‫• در ایران تامین مالی بیشتر از چه طریقی صورت میگیرد؟‬
‫• بانک‬
‫• بازار بدهی(اوراق بدهی شرکتها)‬
‫• بورس(عرضه اولیه)‬
‫• صندوقهای سرمایهگذاری مشترک‬

‫‪50‬‬
 Conclusion

Markets are usually a good way to organize economic activity

• Financial markets: governed by the forces of supply and
demand
▪ Help allocate the economy’s scarce resources to their most efficient
uses.
▪ Link the present to the future
o Savers: convert current income into future purchasing power
o Borrowers: acquire capital to produce goods and services in the
future

51
 Summary

• The U.S. financial system is made up of many types of

financial institutions, like the stock and bond markets, banks,
and mutual funds.
• National saving equals private saving plus
public saving.
• In a closed economy, national saving equals investment. The
financial system makes this happen.

52
 Summary

• The supply of loanable funds comes from saving. The

demand for funds comes from investment. The interest rate
adjusts to balance supply and demand in the loanable funds
market.
• A government budget deficit is negative public saving, so it
reduces national saving, the supply of funds available to
finance investment.
• When a budget deficit crowds out investment,
it reduces the growth of productivity and GDP.

53
 Gross domestic saving(% of GDP)
90

80

70

60

50

40

30

20

10

0
1960 1970 1980 1990 2000 2010 2020

54 Iran, Islamic Rep. United States Turkiye Saudi Arabia