Private vs. Public Saving and Financial Market Dynamics

 
1
 
Today’s Plan
 
Learning Activity A: Private Saving vs. Public Saving
Discussion – NZ 
Superannuation Scheme
 
Learning Activity B: Saving, Investment and Financial Markets
Discussion – 
Investment tax credit vs. Government 
budget deficit
 
Workshop Quiz
 
GDP identity:
     
Y = C + I + G + 
NX
In a closed economy, no trade  =>  
NX = 0
         
Y = C + I + G
         
I = Y – C - G
What is saving?
Define saving as 
current income minus expenditure on current needs.
Current national income: Y (GDP)
Expenditure on current needs: C + G
S 
= Y – C – G
S = I
A. Private Saving vs. Public Saving
Some identities
2
National Saving
Public Saving
S
public 
Private Saving
S
private 
 = 
Household Saving + Business Saving
 
Start with the definition of National saving (S):
S
 = Y – C – G
Add and subtract Net Taxes (T):
S 
= Y – C 
– T  +  T 
– G
Re-arrange the terms:
S
                =                      
(Y – T – C)
                     +            
 (T – G)
A. Private Saving vs. Public Saving
Splitting national saving into two parts
3
 
Public saving:
      
S
public 
= T – G
Balanced
 Government 
Budget
:
       
T = G   and   
S
public 
= 0
Government 
Budget (Fiscal) 
Deficit
:
excess of government spending over tax collections
      
T < G   and   
S
public 
< 0
Government 
Budget (Fiscal) Surplus
:
       
T > G   and   
S
public 
 > 0
the government budget surplus (T – G) equals public saving
A. Private Saving vs. Public Saving
Budget Surplus and Deficit
4
B. Saving, Investment and Financial Market
Demand-Supply Analysis
 
People’s decisions to save and or invest can be modelled with our simple
supply and demand model by making some general simplifications.
 
Financial markets coordinate the economy’s saving and investment in the
market for loanable funds.
Loanable funds: 
all income that people have chosen to save and lend
out, rather than use for their own consumption.
The supply of loanable funds: 
households and firms who have extra
income they want to save and lend out.
The demand for loanable funds: 
households and firms that wish to
borrow to make investments.
5
 
Why does the demand for loanable funds
decrease with the real interest rate?
 
Interest payment is the 
COST
 of
borrowing; so when interest rate goes 
up
(
down
) the cost of borrowing goes 
up
(
down
)
 
With 
higher
 (
lower
) interest rates people
borrow 
less
 (
more
).
 
B. Saving, Investment and Financial Market
Demand-Supply Analysis
6
 
Why does the supply of loanable funds
increase with the real interest rate?
Interest payment is the 
EARNING
 from
savings.
 
So when interest rate goes 
up
 (
down
)
people are inclined to save 
more
 (
less
).
B. Saving, Investment and Financial Market
Demand-Supply Analysis
7
 
 
In the market for loanable funds, the 
real
interest rate 
equates the quantity of
saving supplied and demanded.
B. Saving, Investment and Financial Market
Demand-Supply Analysis
 
8
0
5%
$1,200
Demand
(Investment)
B. Saving, Investment and Financial Market
Discussion: Impacts of 
an investment tax credit
Real Interest
Rate
Loanable Funds
($ billions)
Suppose the government
offers investment tax credits
so that firms pay lower tax
on funds invested in new
productive capacity.
How does this policy affect
the curves in the market
for loanable funds?
How does the interest rate
change?
9
Supply
(Saving=Y-C-G)
 
Interest rate will go up
 
Quantity of funds goes up
Suppose the government runs
budget deficits.
How do budget deficits affect
the curves in the market for
loanable funds?
How does the interest rate
change?
B. Saving, Investment and Financial Market
Discussion: What if the government runs budget deficit?
10
0
5%
$1,200
Demand
(Investment)
Real Interest
Rate
Loanable Funds
($ billions)
Supply
(Saving=Y-C-G)
Since the 1900s, improvements in medical
and nutrition conditions have allowed
people to live much longer than before.
Should people save more than before?
 
Why do people save?
 
11
 
12
Discussion: NZ Superannuation Scheme
 
What does this scheme look like?
During your entire career, you need to contribute via the income tax.
For someone who starts working at 18, in 47 years, you will be
eligible for collecting the weekly payment.
What may affect the rate of return to this scheme?
13
Discussion: NZ Superannuation Scheme
 
Given the 
rising life expectation 
and the 
falling fertility rate
 (children per
women), what kind of challenges will NZ government face in the future?
 
 
 
If you are 
Chief Economic Advisor 
of NZ Treasury, can you offer some policy
solutions to the problem of ageing population?
How would these policies affect your current saving decision?
14
Discussion: NZ Superannuation Scheme
 
Reflections on designing public policies
Did NZ government anticipate the population ageing when it first introduced
the superannuation scheme in 1970s?
The life expectancy and the fertility rate at that time?
15
 
Socrative.com
Chaudhuri251
 
16
Question #1
17
 
Suppose the nominal interest rate on savings deposits in 3% and
inflation is running at 5%. Which of the following statements is
true?
 
We know that 
Real interest rate = Nominal Interest rate – Inflation
rate
 
So, Real interest rate = 
3% - 5% = (-)2%
 
This means if you save your money then it will lose value over time;
it is almost as if $100 today will be worth $98 in one year. So, you
are better off spending your money now rather than saving it.
Question #2
18
 
In a closed economy, what does (Y - T - C) represent?
 
Private saving
 
 
 
 
National Saving
Public Saving
S
public 
Private Saving
S
private 
 = 
Household Saving + Business Saving
Start with the definition of National saving (S):
S
 = Y – C – G
Add and subtract Net Taxes (T):
S 
= Y – C 
– T  +  T 
– G
Re-arrange the terms:
S
                =                      
(Y – T – C)
                     +            
 (T – G)
A. Private Saving vs. Public Saving
Splitting national saving into two parts
19
Question #3
20
 
Suppose that in a closed economy GDP is equal to 8,000.
Consumption equals 5,000 while Investment is 1,000.
What is the value of Government expenditure?
 
We know that in a closed economy Y (GDP) = C + I + G
 
IF Y = 8000, C = 5000 and I = 1000 then
 
Y = C + I + G implies
 
8000 = 5000 + 1000 + G
 
Or G = 2000.
 
 
 
Question #4
21
Suppose that in a closed economy GDP is equal to 8,000, Taxes are equal to 2,000,
Consumption equals 5,000, and Government expenditures equal 1,000.  How much is
private saving? How much is public saving? How much is national saving?
 
Private saving = Y – T – C = 8000 – 2000 – 5000 = 1000
 
Public saving = T – G = 2000-1000 = 1000
 
National saving = Private Saving + Public Saving = 2000
Question #5
22
 
What would happen in the market for loanable funds if the
government were to increase the tax on income earned from
interest paid on savings?
 
If interest income is taxed then savings become less attractive.
 
This will lead to a reduction in saving and therefore, the supply of
loanable funds.
 
 
0
5%
$1,200
Demand
(Investment)
Question #5
Real Interest
Rate
Loanable Funds
($ billions)
23
Supply
(Saving=Y-C-G)
If interest income is 
taxed then this will
reduce the supply of 
loanable funds and 
result in an increase 
in the real interest rate
 
Interest rate will rise from 5%
to something higher
 
Quantity of funds drops
Question #6
24
 
Suppose the government institutes an investment tax credit.
What would happen in the market for loanable funds?
 
 
This makes investment more attractive and create an increase in
the demand for loanable funds.
 
Demand for loanable funds will shift to the right.
0
5%
$1,200
Demand
(Investment)
Question #6
Real Interest
Rate
Loanable Funds
($ billions)
25
Supply
(Saving=Y-C-G)
If investment becomes 
more attractive then 
demand for loanable 
funds shifts to the right
resulting in an increase
in the interest rate. 
 
Interest rate will rise from 5%
to something higher
 
Quantity of funds increases
Question #7
26
 
A higher interest rate induces people to:
 
Save more and hence the supply of loanable funds slopes upwards.
 
Invest less and hence the demand for loanable funds
slopes downwards.
Question #8
27
 
If Taxes > Government spending
Then we have public (government) saving.
 
If Taxes < Government spending
Then we have a budget deficit.
 
Review of Learning Outcomes
 
Upon successful completion of this week’s module, you should be able to:
distinguish between 
private and public saving
,
explain the role of the 
loanable funds market 
in coordinating saving and
investment,
explore the impacts of 
population ageing 
on NZ superannuation scheme
and on individual saving decision
 
28
 
                
Net Present Value
 
An acquaintance is asking you to buy “bonds” of a
new start-up.
If you invest 
$1000 
then they will return 
$1200 
in
two
 
years time.
The current real interest rate is 10% and will remain
unchanged in the foreseeable future.
 
Should you buy this bond?
 
 
 
29
                  
                  
Calculating Net Present Value
 
If interest is paid each year, and if the interest paid
remains in the bank account to earn more interest
(a process called 
compounding
) then the $100 will
become:
 (1+ r) x $100 after one year.
After 2 years, the amount becomes
 (1+r) x (1+r) x $100 = (1+r)
2 
x $100
After 3 years, it will become
 (1+r) x (1+r) x (1+r) x $100 = (1+r)
3
 x $100
 
 
30
                  
                  
Calculating Net Present Value
 
Suppose interest rate is 5%.
Start with $1000.
At the end of the year: $1000 + 0.05X$1000 =
$1000X(1+0.05) = $1050
At the end of second year: $1050 + 0.05X$1050 =
($1000 + 0.05X$1000) + 0.05 ($1000 + 0.05X$1000) =
($1000 + 0.05X$1000)(1 + 0.05) = $1000X(1.05)(1.05)
At the end of the third year the amount becomes
$1000X(1.05) x (1.05) x(1.05) = (1.05)^3
 
x $100
After 4 years, it will become $1000X(1.05)^4
31
                  
Calculating Net Present Value
 
After 10 years then the amount will be:
 (1+r)
10
 x $100.
If the interest rate is 5%, i.e., r = 0.05 then the amount
after 10 years will be:
 (1+0.05)
10
 x 100 = (1.05)
10
 x 100 = $163.
In general then, after N years the amount will be:
(1+r)
N
 x 100
If r = 0.05 then this is equal to (1.05)
N
 x100
32
                 
                 
Calculating Net Present Value
 
Question: 
Now suppose you are going to be paid
$200 in 10 years. What is the present value of this
investment? That is how much would you have to
invest to get $200 in 10 years?
Answer:
 To answer this question turn the previous
answer on its head
33
       
                  
Calculating Net Present Value
 
34
 
Another way to think of this is the following:
Suppose the present value of $200 in 10 years is $X.
 
Then it must be the case that: 
(1+r)
10
 x $X = $200
 
 
Rearranging this equation means that:  
$X = $200/ (1+r)
10
 
 
Again if r = 0.05 then this is equal to:  
$200/ (1.05)
10
 =
 
$123.
 
If r = 0.05 then this works out to: 
$200/(1.05)
10
 = $123.
 
                  
Calculating Net Present Value
 
You have the option of making the following
investment.
 
You can buy a “bond” for 
$1000 
and the bond will
pay you 
$1200 
in 
two
 
years time.
 
The current real interest rate is 10% and will remain
unchanged in the foreseeable future.
 
Should you buy this bond?
 
 
 
35
                  
                  
Calculating Net Present Value
 
No. Why?
 
In 2 years’ time $1000 will become $1000 (1.1)^2 = $1210 which is
bigger than $1200. You are better off investing the $1000 elsewhere at
10%.
 
Or Net Present Value of $1200 in two years = $1200/(1.1)^2 = $992.
 
So you should buy the bond if and only if you can buy it for $992 or less.
But if current price more than $992 then do not buy the bond. You will
do better getting 10% elsewhere.
 
36
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Explore the concepts of private and public saving in relation to national income, expenditure, and government fiscal policies. Delve into the analysis of saving, investment, financial markets, and the impact of real interest rates on loanable funds. Gain insights into the relationships between saving, investment, and government budget deficits/surpluses.

  • Saving
  • Investment
  • Financial Markets
  • National Income
  • Fiscal Policy

Uploaded on Jul 19, 2024 | 2 Views


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  1. Todays Plan Learning Activity A: Private Saving vs. Public Saving Discussion NZ Superannuation Scheme Learning Activity B: Saving, Investment and Financial Markets Discussion Investment tax credit vs. Government budget deficit Workshop Quiz 1

  2. A. Private Saving vs. Public Saving Some identities GDP identity: In a closed economy, no trade => NX = 0 What is saving? Define saving as current income minus expenditure on current needs. Current national income: Y (GDP) Expenditure on current needs: C + G S = Y C G S = I Y = C + I + G + NX Y = C + I + G I = Y C - G 2

  3. A. Private Saving vs. Public Saving Splitting national saving into two parts Start with the definition of National saving (S): S = Y C G Add and subtract Net Taxes (T): S = Y C T + T G Re-arrange the terms: S = (Y T C) + (T G) National Saving Private Saving Public Saving Spublic Sprivate = Household Saving + Business Saving 3

  4. A. Private Saving vs. Public Saving Budget Surplus and Deficit Public saving: Balanced Government Budget: Government Budget (Fiscal) Deficit: excess of government spending over tax collections T < G and Spublic < 0 Government Budget (Fiscal) Surplus: T > G and Spublic > 0 the government budget surplus (T G) equals public saving Spublic = T G T = G and Spublic = 0 4

  5. B. Saving, Investment and Financial Market Demand-Supply Analysis People s decisions to save and or invest can be modelled with our simple supply and demand model by making some general simplifications. Financial markets coordinate the economy s saving and investment in the market for loanable funds. Loanable funds: all income that people have chosen to save and lend out, rather than use for their own consumption. The supply of loanable funds: households and firms who have extra income they want to save and lend out. The demand for loanable funds: households and firms that wish to borrow to make investments. 5

  6. B. Saving, Investment and Financial Market Demand-Supply Analysis Real Interest Rate Why does the demand for loanable funds decrease with the real interest rate? Interest payment is the COST of borrowing; so when interest rate goes up (down) the cost of borrowing goes up (down) 5% Demand (Investment) With higher (lower) interest rates people borrow less (more). Loanable Funds ($ billions) 0 $1,200 6

  7. B. Saving, Investment and Financial Market Demand-Supply Analysis Real Interest Rate Why does the supply of loanable funds increase with the real interest rate? Supply S=Y-C-G Interest payment is the EARNING from savings. 5% So when interest rate goes up (down) people are inclined to save more (less). Loanable Funds ($ billions) 0 $1,200 7

  8. B. Saving, Investment and Financial Market Demand-Supply Analysis Real Interest Rate Supply S=Y-C-G In the market for loanable funds, the real interest rate equates the quantity of saving supplied and demanded. 5% Demand (Investment) Loanable Funds ($ billions) 0 $1,200 8

  9. B. Saving, Investment and Financial Market Discussion: Impacts of an investment tax credit Real Interest Interest rate will go up Rate Suppose the government offers investment tax credits so that firms pay lower tax on funds invested in new productive capacity. Supply (Saving=Y-C-G) 5% How does this policy affect the curves in the market for loanable funds? Demand (Investment) How does the interest rate change? Loanable Funds ($ billions) 0 $1,200 Quantity of funds goes up 9

  10. B. Saving, Investment and Financial Market Discussion: What if the government runs budget deficit? Real Interest Rate Suppose the government runs budget deficits. Supply (Saving=Y-C-G) How do budget deficits affect the curves in the market for loanable funds? 5% How does the interest rate change? Demand (Investment) Loanable Funds ($ billions) 0 $1,200 10

  11. Why do people save? Since the 1900s, improvements in medical and nutrition conditions have allowed people to live much longer than before. Should people save more than before? 11

  12. 12

  13. Discussion: NZ Superannuation Scheme How much does the currently old generation get per year? ????????????? ?????? ??????? How much does the currently young generation pay per year? ??????????????? ?????? ???????????? Suppose NZ government needs to balance the budget on this scheme. ????????????? ?????? ??????? = ??????????????? ?????? ???????????? What does this scheme look like? During your entire career, you need to contribute via the income tax. For someone who starts working at 18, in 47 years, you will be eligible for collecting the weekly payment. What may affect the rate of return to this scheme? 13

  14. Discussion: NZ Superannuation Scheme Given the rising life expectation and the falling fertility rate (children per women), what kind of challenges will NZ government face in the future? ? ????????????? ?????? ???????= ??????????????? ?????? ???????????? If you are Chief Economic Advisor of NZ Treasury, can you offer some policy solutions to the problem of ageing population? How would these policies affect your current saving decision? 14

  15. Discussion: NZ Superannuation Scheme ????????????? ?????? ??????? = ??????????????? ?????? ???????????? Raise ???????????????? Raise the Annual Contribution? Reduce Annual Payment? Reflections on designing public policies Did NZ government anticipate the population ageing when it first introduced the superannuation scheme in 1970s? The life expectancy and the fertility rate at that time? 15

  16. Socrative.com Chaudhuri251 16

  17. Question #1 Suppose the nominal interest rate on savings deposits in 3% and inflation is running at 5%. Which of the following statements is true? We know that Real interest rate = Nominal Interest rate Inflation rate So, Real interest rate = 3% - 5% = (-)2% This means if you save your money then it will lose value over time; it is almost as if $100 today will be worth $98 in one year. So, you are better off spending your money now rather than saving it. 17

  18. Question #2 In a closed economy, what does (Y - T - C) represent? Private saving 18

  19. A. Private Saving vs. Public Saving Splitting national saving into two parts Start with the definition of National saving (S): S = Y C G Add and subtract Net Taxes (T): S = Y C T + T G Re-arrange the terms: S = (Y T C) + (T G) National Saving Private Saving Public Saving Spublic Sprivate = Household Saving + Business Saving 19

  20. Question #3 Suppose that in a closed economy GDP is equal to 8,000. Consumption equals 5,000 while Investment is 1,000. What is the value of Government expenditure? We know that in a closed economy Y (GDP) = C + I + G IF Y = 8000, C = 5000 and I = 1000 then Y = C + I + G implies 8000 = 5000 + 1000 + G Or G = 2000. 20

  21. Question #4 Suppose that in a closed economy GDP is equal to 8,000, Taxes are equal to 2,000, Consumption equals 5,000, and Government expenditures equal 1,000. How much is private saving? How much is public saving? How much is national saving? Private saving = Y T C = 8000 2000 5000 = 1000 Public saving = T G = 2000-1000 = 1000 National saving = Private Saving + Public Saving = 2000 21

  22. Question #5 What would happen in the market for loanable funds if the government were to increase the tax on income earned from interest paid on savings? If interest income is taxed then savings become less attractive. This will lead to a reduction in saving and therefore, the supply of loanable funds. 22

  23. Question #5 Interest rate will rise from 5% to something higher Real Interest Rate If interest income is taxed then this will reduce the supply of loanable funds and result in an increase in the real interest rate Supply (Saving=Y-C-G) 5% Demand (Investment) Loanable Funds ($ billions) 0 $1,200 Quantity of funds drops 23

  24. Question #6 Suppose the government institutes an investment tax credit. What would happen in the market for loanable funds? This makes investment more attractive and create an increase in the demand for loanable funds. Demand for loanable funds will shift to the right. 24

  25. Question #6 Interest rate will rise from 5% to something higher Real Interest Rate Supply (Saving=Y-C-G) If investment becomes more attractive then demand for loanable funds shifts to the right resulting in an increase in the interest rate. 5% Demand (Investment) Loanable Funds ($ billions) 0 $1,200 Quantity of funds increases 25

  26. Question #7 A higher interest rate induces people to: Save more and hence the supply of loanable funds slopes upwards. Invest less and hence the demand for loanable funds slopes downwards. 26

  27. Question #8 If Taxes > Government spending Then we have public (government) saving. If Taxes < Government spending Then we have a budget deficit. 27

  28. Review of Learning Outcomes Upon successful completion of this week s module, you should be able to: distinguish between private and public saving, explain the role of the loanable funds market in coordinating saving and investment, explore the impacts of population ageing on NZ superannuation scheme and on individual saving decision 28

  29. An acquaintance is asking you to buy bonds of a new start-up. If you invest $1000 then they will return $1200 in two years time. The current real interest rate is 10% and will remain unchanged in the foreseeable future. Should you buy this bond? 29

  30. If interest is paid each year, and if the interest paid remains in the bank account to earn more interest (a process called compounding) then the $100 will become: (1+ r) x $100 after one year. After 2 years, the amount becomes (1+r) x (1+r) x $100 = (1+r)2 x $100 After 3 years, it will become (1+r) x (1+r) x (1+r) x $100 = (1+r)3 x $100 30

  31. Suppose interest rate is 5%. Start with $1000. At the end of the year: $1000 + 0.05X$1000 = $1000X(1+0.05) = $1050 At the end of second year: $1050 + 0.05X$1050 = ($1000 + 0.05X$1000) + 0.05 ($1000 + 0.05X$1000) = ($1000 + 0.05X$1000)(1 + 0.05) = $1000X(1.05)(1.05) At the end of the third year the amount becomes $1000X(1.05) x (1.05) x(1.05) = (1.05)^3x $100 After 4 years, it will become $1000X(1.05)^4 31

  32. After 10 years then the amount will be: (1+r)10 x $100. If the interest rate is 5%, i.e., r = 0.05 then the amount after 10 years will be: (1+0.05)10 x 100 = (1.05)10 x 100 = $163. In general then, after N years the amount will be: (1+r)N x 100 If r = 0.05 then this is equal to (1.05)N x100 32

  33. Question: Now suppose you are going to be paid $200 in 10 years. What is the present value of this investment? That is how much would you have to invest to get $200 in 10 years? Answer: To answer this question turn the previous answer on its head 33

  34. If r = 0.05 then this works out to: $200/(1.05)10 = $123. Another way to think of this is the following: Suppose the present value of $200 in 10 years is $X. Then it must be the case that: (1+r)10 x $X = $200 Rearranging this equation means that: $X = $200/ (1+r)10 Again if r = 0.05 then this is equal to: $200/ (1.05)10 = $123. 34

  35. You have the option of making the following investment. You can buy a bond for $1000 and the bond will pay you $1200 in two years time. The current real interest rate is 10% and will remain unchanged in the foreseeable future. Should you buy this bond? 35

  36. No. Why? In 2 years time $1000 will become $1000 (1.1)^2 = $1210 which is bigger than $1200. You are better off investing the $1000 elsewhere at 10%. Or Net Present Value of $1200 in two years = $1200/(1.1)^2 = $992. So you should buy the bond if and only if you can buy it for $992 or less. But if current price more than $992 then do not buy the bond. You will do better getting 10% elsewhere. 36

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