capital markets
TRANSCRIPT
![Page 1: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/1.jpg)
Capital Markets
Savings, Investment, and Interest Rates
www.StudsPlanet.com
![Page 2: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/2.jpg)
Some Useful Terminology
• Savings: Current income which is deferred for future consumption (i.e., not spent)
www.StudsPlanet.com
![Page 3: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/3.jpg)
Some Useful Terminology
• Savings: Current income which is deferred for future consumption (i.e., not spent)
National Income: $8,512.3 B
+ Dividend Payments, Interest, Gov’t Transfers, etc.: $582.5B
- Taxes: $1,077.2 B
= Personal Disposable Income: $8,017.6 B
- Personal Consumption Expenditures: $7,727.2 B
= Personal Savings: $290.4B (3.5% of Personal Income)
www.StudsPlanet.com
![Page 4: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/4.jpg)
Some Useful Terminology
• Savings: Current income which is deferred for future consumption (i.e., not spent)
National Income: $8,512.3 B
+ Dividend Payments, Interest, Gov’t Transfers, etc.: $582.5B
- Taxes: $1,077.2 B
= Personal Disposable Income: $8,017.6 B
- Personal Consumption Expenditures: $7,727.2 B
= Personal Savings: $290.4B (3.5% of Personal Income)
• Note that there are many ways to save (savings account, bonds, stocks, etc.)
www.StudsPlanet.com
![Page 5: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/5.jpg)
Some Useful Terminology
• Investment: The purchase of new capital goods.
www.StudsPlanet.com
![Page 6: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/6.jpg)
Some Useful Terminology
• Investment: The purchase of new capital goods.
– Gross Investment: Total purchases of new capital goods
www.StudsPlanet.com
![Page 7: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/7.jpg)
Some Useful Terminology
• Investment: The purchase of new capital goods.
– Gross Investment: Total purchases of new capital goods• Gross Private Investment: $1,611.2 B
• Gross Public Investment: $355 B
www.StudsPlanet.com
![Page 8: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/8.jpg)
Some Useful Terminology
• Investment: The purchase of new capital goods. – Gross Investment: Total purchases of new capital goods
• Gross Private Investment: $1,611.2 B• Gross Public Investment: $355 B
– Net Investment: Gross investment less depreciation of existing capital (capital consumption)
• Net Private Investment: $500 B• Net Public Investment: $250 B
www.StudsPlanet.com
![Page 9: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/9.jpg)
NIPA Accounts
• Recall, the accounting identity in the NIPA accounts: GDP = C + I + G + NX
www.StudsPlanet.com
![Page 10: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/10.jpg)
NIPA Accounts
• Recall, the accounting identity in the NIPA accounts: GDP = C + I + G + NX
• GDP = Gross Private Savings + Taxes + C
www.StudsPlanet.com
![Page 11: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/11.jpg)
NIPA Accounts
• Recall, the accounting identity in the NIPA accounts: GDP = C + I + G + NX
• GDP = Gross Private Savings + Taxes + C
Gross Private Savings = I + (G-T) + NX
I (Public + Private) : $1,966 B
+ (G-T): $106B
+ NX: - $559B
Gross Private Savings: $1,513B (16% of GDP)
www.StudsPlanet.com
![Page 12: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/12.jpg)
NIPA Accounts
• Recall, the accounting identity in the NIPA accounts: GDP = C + I + G + NX
• GDP = Gross Savings + Taxes + CI + (G-T) + NX = Gross Private Savings
I (Public + Private) : $1,966 B+ (G-T): $123B + NX: - $487B
Gross Private Savings: $1,513B
Personal Savings ($290B) = Gross Private Saving ($1,513B) - Depreciation
www.StudsPlanet.com
![Page 13: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/13.jpg)
Interest Rates
• What is an interest rate?
www.StudsPlanet.com
![Page 14: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/14.jpg)
Interest Rates
• What is an interest rate?– The interest rate is the relative price of current
spending in terms of foregone future income.
www.StudsPlanet.com
![Page 15: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/15.jpg)
Interest Rates
• What is an interest rate?– The interest rate is the relative price of current
spending in terms of foregone future income.– Example: if the interest rate is 5% (Annual),
you must give up $1.05 worth of next year’s income in order to increase this year’s spending by $1.
www.StudsPlanet.com
![Page 16: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/16.jpg)
Interest Rates:1987-2003
0123456789
10
1/1/
87
1/1/
89
1/1/
91
1/1/
93
1/1/
95
1/1/
97
1/1/
99
1/1/
01
1/1/
03
3 Mo. T-Bill
www.StudsPlanet.com
![Page 17: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/17.jpg)
Interest Rates:1987-2003
0123456789
10
1/1/
87
1/1/
89
1/1/
91
1/1/
93
1/1/
95
1/1/
97
1/1/
99
1/1/
01
1/1/
03
3 Mo. T-Bill10 Year T-Note
www.StudsPlanet.com
![Page 18: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/18.jpg)
The Yield Curve
www.StudsPlanet.com
![Page 19: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/19.jpg)
Yield Curves
• What determines the shape of the yield curve?– Segmented Markets Hypothesis– Expectations Hypothesis– Preferred Habitat Hypothesis
www.StudsPlanet.com
![Page 20: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/20.jpg)
Interest Rates:1987-2003
0
2
4
6
8
10
12
1/1/
87
1/1/
89
1/1/
91
1/1/
93
1/1/
95
1/1/
97
1/1/
99
1/1/
01
1/1/
03
3 Mo. T-Bill10 Year T-NoteAAA Corp.
www.StudsPlanet.com
![Page 21: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/21.jpg)
Interest Rates
• Treasury Securities (1 - 5%)• Agency Securities (1 - 5%)• Municipal Bonds (3 – 5%)• Corporate Bonds (6 – 11%)• Preferred Stock (5 – 15%)• Asset Backed Securities (4 – 5%)
www.StudsPlanet.com
![Page 22: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/22.jpg)
Interest Rates
• Treasury Securities (1 - 5%)• Agency Securities (1 - 5%)• Municipal Bonds (3 – 5%)• Corporate Bonds (6 – 11%)• Preferred Stock (5 – 15%)• Asset Backed Securities (4 – 5%)
• “Risky” Rate = Risk Free Rate + Risk Premium
www.StudsPlanet.com
![Page 23: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/23.jpg)
Real vs. Nominal Interest Rates
• As with any other variable, the nominal interest rate is in terms of dollars. (the cost of a current dollar in terms of forgone future dollars). To calculate the real interest rate, we need to correct for the purchasing power of those dollars.
www.StudsPlanet.com
![Page 24: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/24.jpg)
Real vs. Nominal Interest Rates
• As with any other variable, the nominal interest rate is in terms of dollars. (the cost of a current dollar in terms of forgone future dollars). To calculate the real interest rate, we need to correct for the purchasing power of those dollars.
• Exact: (1+i ) = (1+ r )*(1 + inflation rate)
www.StudsPlanet.com
![Page 25: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/25.jpg)
Real vs. Nominal Interest Rates
• As with any other variable, the nominal interest rate is in terms of dollars. (the cost of a current dollar in terms of forgone future dollars). To calculate the real interest rate, we need to correct for the purchasing power of those dollars.
• Exact: (1+i ) = (1+ r )*(1 + inflation rate)
• Approximation: i = r + inflation rate
www.StudsPlanet.com
![Page 26: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/26.jpg)
Real/Nominal Interest Rates
-10
-5
0
5
10
15
20
1/1/
1965
1/1/
1968
1/1/
1971
1/1/
1974
1/1/
1977
1/1/
1980
1/1/
1983
1/1/
1986
1/1/
1989
1/1/
1992
1/1/
1995
1/1/
1998
1/1/
2001
InflationRealNominal
www.StudsPlanet.com
![Page 27: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/27.jpg)
Real vs. Nominal Interest Rates
• As with any other variable, the nominal interest rate is in terms of dollars. (the cost of a current dollar in terms of forgone future dollars). To calculate the real interest rate, we need to correct for the purchasing power of those dollars.
• Exact: (1+i ) = (1+ r )*(1 + inflation rate)
• Approximation: i = r + inflation rate
• How can real interest rates be negative?
www.StudsPlanet.com
![Page 28: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/28.jpg)
Real vs. Nominal Interest Rates
• As with any other variable, the nominal interest rate is in terms of dollars. (the cost of a current dollar in terms of forgone future dollars). To calculate the real interest rate, we need to correct for the purchasing power of those dollars.
• Exact: (1+i ) = (1+ r )*(1 + inflation rate)
• Approximation: i = r + inflation rate
• How can real interest rates be negative?
– Ex ante vs. ex post
www.StudsPlanet.com
![Page 29: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/29.jpg)
Present Value
• With a positive interest rate, income received in the future is less valuable that income received immediately.
www.StudsPlanet.com
![Page 30: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/30.jpg)
Present Value
• With a positive interest rate, income received in the future is less valuable that income received immediately.
• At a 5% annual interest rate, $1.05 to be received in one year is equivalent to $1 to be received today (because $1 today could be worth $1.05)
$1(1.05) = $1.05
www.StudsPlanet.com
![Page 31: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/31.jpg)
Present Value
• With a positive interest rate, income received in the future is less valuable that income received immediately.
• At a 5% annual interest rate, $1.05 to be received in one year is equivalent to $1 to be received today (because $1 today could be worth $1.05)
$1(1.05) = $1.05
• Therefore, the present value of $1.05 to be paid in one year (if the annual interest rate is 5%) is $1.
www.StudsPlanet.com
![Page 32: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/32.jpg)
Present Value
• With a positive interest rate, income received in the future is less valuable that income received immediately.
• At a 5% annual interest rate, $1.05 to be received in one year is equivalent to $1 to be received today (because $1 today could be worth $1.05)
$1(1.05) = $1.05
• Therefore, the present value of $1.05 to be paid in one year (if the annual interest rate is 5%) is $1.
• In general, the PV of $X to be paid in N years is equal to
PV = $X/(1+i)^N
www.StudsPlanet.com
![Page 33: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/33.jpg)
Income vs. Wealth
• Your wealth is defined and the present value of your lifetime income.
www.StudsPlanet.com
![Page 34: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/34.jpg)
Income vs. Wealth
• Your wealth is defined and the present value of your lifetime income.
• For example, suppose you expect your annual income to be $50,000 per year for the rest of your life. If the annual interest rate is 3%:Wealth = $50,000 + $50,000/(1.03) + $50,000/(1.03)^2 + ……
= $50,000/(.03) = $1,666,666 (Approx)
www.StudsPlanet.com
![Page 35: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/35.jpg)
Household Savings
• Without an active capital markets, household consumption is restricted to equal current income (that is, C=Y)
www.StudsPlanet.com
![Page 36: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/36.jpg)
Household Savings
• Without an active capital markets, household consumption is restricted to equal current income (that is, C=Y)
• With capital markets, the present value of lifetime consumption must equal the present value of lifetime income (assuming all debts are eventually repaid)
www.StudsPlanet.com
![Page 37: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/37.jpg)
A two period example
• Suppose that your current income is equal to $50,000 and you anticipate next year’s income to be $60,000. The current interest rate is 5%.
www.StudsPlanet.com
![Page 38: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/38.jpg)
A two period example
• Suppose that your current income is equal to $50,000 and you anticipate next year’s income to be $60,000. The current interest rate is 5%.
• In the absence of capital markets, your consumption stream would be $50,000 this year and $60,000 next year.
www.StudsPlanet.com
![Page 39: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/39.jpg)
Consumption Possibilities
0102030405060708090
100
0 10 20 30 40 50 60 70 80 90 100
Current Consumption (000s)
Fut
ure
Con
sum
ptio
n (0
00s)
www.StudsPlanet.com
![Page 40: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/40.jpg)
Borrowing to increase current consumption
• To increase your current consumption, you could take out a loan. Your current consumption would now be C = $50,000 + Loan
www.StudsPlanet.com
![Page 41: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/41.jpg)
Borrowing to increase current consumption
• To increase your current consumption, you could take out a loan. Your current consumption would now be
C = $50,000 + Loan• However, you must repay your loan next year.
This implies that
C’= $60,000 – (1.05)Loan
www.StudsPlanet.com
![Page 42: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/42.jpg)
Borrowing to increase current consumption
• To increase your current consumption, you could take out a loan. Your current consumption would now be
C = $50,000 + Loan
• However, you repay your loan next year. This implies that
C’= $60,000 – (1.05)Loan
• For example, if you take out a $10,000 loan, your current consumption would be $60,000, while your future income would be $60,000 - $10,000(1.05) = $49,500
www.StudsPlanet.com
![Page 43: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/43.jpg)
Consumption Possibilities
0102030405060708090
100
0 10 20 30 40 50 60 70 80 90 100Current Consumption (000s)
Fu
tue
r C
on
su
mp
tio
n (
00
0s)
www.StudsPlanet.com
![Page 44: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/44.jpg)
Borrowing Limits
Note that you need to be able to repay your loan next year. Therefore,
$60,000 > (1.05)Loan
www.StudsPlanet.com
![Page 45: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/45.jpg)
Borrowing Limits
• Note that you need to be able to repay your loan next year. Therefore,
$60,000 = (1.05)Loan
• Your maximum allowable loan is $60,000/1.05 = $57,143 (this is associated with zero future consumption)
www.StudsPlanet.com
![Page 46: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/46.jpg)
Borrowing Limits
• Note that you need to be able to repay your loan next year. Therefore, $60,000 = (1.05)LoanYour maximum allowable loan is $60,000/1.05 = $57,143 (this is associated with zero future consumption)Therefore, your maximum current consumption is $107,143
www.StudsPlanet.com
![Page 47: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/47.jpg)
Consumption Possibilities
0
20
40
60
80
100
120
0 10 20 30 40 50 60 70 80 90 100 110 120
Current Consumption (000s)
Fu
tue
r C
on
su
mp
tio
n (
00
0s)
www.StudsPlanet.com
![Page 48: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/48.jpg)
Consumption Possibilities
0
20
40
60
80
100
120
0 10 20 30 40 50 60 70 80 90 100 110 120
Current Consumption (000s)
Fu
tue
r C
on
su
mp
tio
n (
00
0s)
www.StudsPlanet.com
![Page 49: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/49.jpg)
Saving to increase future consumption
• You could increase future consumption by saving some of your income (i.e. a negative loan). Suppose you put $20,000 in the bank, your current consumption is now $30,000.
www.StudsPlanet.com
![Page 50: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/50.jpg)
Saving to increase future consumption
• You could increase future consumption by saving some of your income (i.e. a negative loan). Suppose you put $20,000 in the bank, your current consumption is now $30,000.
• Next year, your bank account will be worth $20,000(1.05) = $21,000. Therefore, your future consumption will be $81,000
www.StudsPlanet.com
![Page 51: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/51.jpg)
Consumption Possibilities
0
20
40
60
80
100
120
0 10 20 30 40 50 60 70 80 90 100 110 120
Current Consumption (000s)
Fu
tue
r C
on
su
mp
tio
n (
00
0s)
www.StudsPlanet.com
![Page 52: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/52.jpg)
Maximizing future consumption
• Suppose you save your entire income. Your current consumption will be zero, but your future consumption will be
C’ = $60,000 + $50,000(1.05) = $112,500
www.StudsPlanet.com
![Page 53: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/53.jpg)
Consumption Possibilities
0
20
40
60
80
100
120
0 10 20 30 40 50 60 70 80 90 100 110 120
Current Consumption (000s)
Fu
tue
r C
on
su
mp
tio
n (
00
0s)
www.StudsPlanet.com
![Page 54: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/54.jpg)
Consumption Possibilities
0
20
40
60
80
100
120
0 10 20 30 40 50 60 70 80 90 100 110 120
Current Consumption (000s)
Fu
tue
r C
on
su
mp
tio
n (
00
0s)
www.StudsPlanet.com
![Page 55: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/55.jpg)
Suppose that the interest rate rises to 8%
• Note that if you don’t borrow or lend, you are unaffected.
www.StudsPlanet.com
![Page 56: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/56.jpg)
Suppose that the interest rate rises to 8%
• Note that if you don’t borrow or lend, you are unaffected.
• At higher interest rates, your borrowing limit falls: Loan = $60,000/1.08 = $55,556 (higher interest rates are bad for borrowers)
www.StudsPlanet.com
![Page 57: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/57.jpg)
Suppose that the interest rate rises to 8%
• Note that if you don’t borrow or lend, you are unaffected.
• At higher interest rates, your borrowing limit falls: Loan = $60,000/1.08 = $55,556 (higher interest rates are bad for borrowers)
• However, if you are saving, you receive more interest: $50,000(1.08) = $54,000 (higher interest rates are good for savers)
www.StudsPlanet.com
![Page 58: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/58.jpg)
Consumption Possibilities
Current Consumption (000s)
Futu
er C
onsu
mpt
ion
(000
s)
www.StudsPlanet.com
![Page 59: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/59.jpg)
Consumption Possibilities
Current Consumption (000s)
Futu
re C
onsu
mpt
ion
(000
s)
www.StudsPlanet.com
![Page 60: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/60.jpg)
The interest rate is the relative price of current consumption in terms of future consumption
• When any relative price changes, there are two distinct effects that impact consumer behavior
www.StudsPlanet.com
![Page 61: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/61.jpg)
The interest rate is the relative price of current consumption in terms of future consumption
• When any relative price changes, there are two distinct effects that impact consumer behavior– The substitution effect: as relative prices change, consumer
typically alter purchases to favor the good that has become cheaper
www.StudsPlanet.com
![Page 62: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/62.jpg)
The interest rate is the relative price of current consumption in terms of future consumption
• When any relative price changes, there are two distinct effects that impact consumer behavior– The substitution effect: as relative prices change, consumer
typically alter purchases to favor the good that has become cheaper
– Income Effect: Changing prices alter one’s purchasing power. When purchasing power falls/rises, purchases fall/rise
www.StudsPlanet.com
![Page 63: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/63.jpg)
How does rising interest rates influence savings decisions?
www.StudsPlanet.com
![Page 64: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/64.jpg)
How does rising interest rates influence savings decisions?
• The substitution effect is unambiguous: as interest rates rise, current consumption becomes more expensive. Therefore, consumers spend less (i.e. save more)
www.StudsPlanet.com
![Page 65: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/65.jpg)
How does rising interest rates influence savings decisions?
• The substitution effect is unambiguous: as interest rates rise, current consumption becomes more expensive. Therefore, consumers spend less (i.e. save more)
• The income effect depends on your current situation: borrowers experience a negative income effect and therefore would spend less (save more) while savers experience a positive income effect and therefore would spend more (save less)
www.StudsPlanet.com
![Page 66: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/66.jpg)
Impact of rising interest rates
Borrowers• Substitution effect:
spend less (save more)• Income effect: Spend
less (save more)___________
Net effect: Save More
Savers• Substitution effect:
spend less (save more)• Income effect: spend
more (save less)___________
Net effect: ????
www.StudsPlanet.com
![Page 67: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/67.jpg)
Aggregate Savings
• At the individual level, we would need to consider income and substitution effects to determine the precise impact of rising/falling interest rates on savings behavior
www.StudsPlanet.com
![Page 68: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/68.jpg)
Aggregate Savings
• At the individual level, we would need to consider income and substitution effects to determine the precise impact of rising/falling interest rates on savings behavior
• At the aggregate level, new savings is very close to zero (i.e., there are approximately the same number of borrowers as there are lenders
www.StudsPlanet.com
![Page 69: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/69.jpg)
Aggregate Savings
• At the individual level, we would need to consider income and substitution effects to determine the precise impact of rising/falling interest rates on savings behavior
• At the aggregate level, new savings is very close to zero (i.e., there are approximately the same number of borrowers as there are lenders
• Therefore, the income effects cancel out and higher interest rates have an unambiguous positive effect on savings
www.StudsPlanet.com
![Page 70: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/70.jpg)
Aggregate Savings
0123456789
0 10 20 30 40 50
Savings ($)
Inte
rest
Rat
e (%
)
www.StudsPlanet.com
![Page 71: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/71.jpg)
Again, assume that the interest rate is 5%, consider two individuals
Person A• Current income:
$10,000• Anticipated future
income: $50,000
www.StudsPlanet.com
![Page 72: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/72.jpg)
Again, assume that the interest rate is 5%, consider two individuals
Person A• Current income:
$10,000• Anticipated future
income: $50,000
Person B• Current Income:
$50,000• Anticipated Future
income: $8,000
www.StudsPlanet.com
![Page 73: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/73.jpg)
Again, assume that the interest rate is 5%, consider two individuals
Person A• Current income:
$10,000• Anticipated future
income: $50,000
Wealth: $57,619
Person B• Current Income:
$50,000• Anticipated Future
income: $8,000
www.StudsPlanet.com
![Page 74: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/74.jpg)
Again, assume that the interest rate is 5%, consider two individuals
Person A• Current income:
$10,000• Anticipated future
income: $50,000
Wealth: $57,619
Person B• Current Income:
$50,000• Anticipated Future
income: $8,000
Wealth: $57,619
www.StudsPlanet.com
![Page 75: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/75.jpg)
Consumption vs. Wealth
10
57.6
0
50
0
10
20
30
40
50
60
70
0 10 20 30 40 50 60 70
www.StudsPlanet.com
![Page 76: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/76.jpg)
Consumption and Wealth
• With capital markets, consumption is not determined by current income, but by wealth (present value of lifetime income)
www.StudsPlanet.com
![Page 77: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/77.jpg)
Consumption and Wealth
• With capital markets, consumption is not determined by current income, but by wealth (present value of lifetime income)
• These two individuals, having the same wealth, should choose the same consumption
www.StudsPlanet.com
![Page 78: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/78.jpg)
Consumption vs. Wealth
10
57.6
0
50
0
10
20
30
40
50
60
70
0 10 20 30 40 50 60 70
www.StudsPlanet.com
![Page 79: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/79.jpg)
Again, assume that the interest rate is 5%, consider two individuals
• Person A
• Current income: $10,000
• Anticipated future income: $50,000
Wealth: $57,619
Current Spending: $30,000
Person B
• Current Income: $50,000
• Anticipated Future income: $8,000
Wealth: $57,619
Current Spending: $30,000
www.StudsPlanet.com
![Page 80: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/80.jpg)
Again, assume that the interest rate is 5%, consider two individuals
• Person A
• Current income: $10,000
• Anticipated future income: $50,000
Wealth: $57,619
Current Spending: $30,000
Savings: -$20,000
Person B
• Current Income: $50,000
• Anticipated Future income: $8,000
Wealth: $57,619
Current Spending: $30,000
Savings: $20,000
www.StudsPlanet.com
![Page 81: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/81.jpg)
Again, assume that the interest rate is 5%, consider two individuals
• Person A
• Current income: $10,000
• Anticipated future income: $50,000
Wealth: $57,619
Current Spending: $30,000
Savings: -$20,000
Future Spending: $29,000
Person B
• Current Income: $50,000
• Anticipated Future income: $8,000
Wealth: $57,619
Current Spending: $30,000
Savings: $20,000
Future Spending: $29,000
www.StudsPlanet.com
![Page 82: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/82.jpg)
Consumption and Wealth
• With capital markets, consumption is not determined by current income, but by wealth (present value of lifetime income)
• These two individuals, having the same wealth, should choose the same consumption.
• For a given level of wealth, those with high rates of income growth would be expected to be borrowers
www.StudsPlanet.com
![Page 83: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/83.jpg)
Suppose that economic growth in the US rises. What should happen to aggregate savings?
0123456789
0 10 20 30 40 50
Savings ($)
Inte
rest
Rat
e (%
)
www.StudsPlanet.com
![Page 84: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/84.jpg)
Suppose that economic growth in the US rises. What should happen to aggregate savings?
0
2
4
6
8
10
12
0 10 20 30 40 50
Savings ($)
Inte
rest
Rat
e (%
)
www.StudsPlanet.com
![Page 85: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/85.jpg)
Technology & Investment Demand
• Recall that an economy has three sources of growth: labor, capital, and technology
www.StudsPlanet.com
![Page 86: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/86.jpg)
Production Technology
• Recall that an economy has three sources of growth: labor, capital, and technology
• The production function describes the relationship between output and the three
www.StudsPlanet.com
![Page 87: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/87.jpg)
Production (Holding Employment Fixed)
www.StudsPlanet.com
![Page 88: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/88.jpg)
Production (Holding Employment Fixed)
0102030405060708090
0 2 4 6 8 10
Capital
Out
put
www.StudsPlanet.com
![Page 89: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/89.jpg)
Marginal Product of Capital
• The marginal product of capital is defined as the additional output produced by each additional unit of capital purchased.
• In the previous slide, the first unit of capital generated 25 units of output while the second unit of capital raised total output from 20 to 45
• Therefore, the MPK of the first unit of capital is 25 while the MPK of the second unit of capital is 20
www.StudsPlanet.com
![Page 90: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/90.jpg)
Diminishing marginal product implies that as the capital stock rises, the marginal product of
additional capital falls
0102030405060708090
0 2 4 6 8 10
Capital
Outp
ut
0
5
10
15
20
25
30
www.StudsPlanet.com
![Page 91: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/91.jpg)
Marginal Product and Investment Demand
• Recall that investment refers to the purchase of new capital equipment by the private sector
www.StudsPlanet.com
![Page 92: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/92.jpg)
Marginal Product and Investment Demand
• Recall that investment refers to the purchase of new capital equipment by the private sector
• Firms are profit maximizers and, hence, only take actions that increase firm value (present value of lifetime earnings)
www.StudsPlanet.com
![Page 93: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/93.jpg)
Marginal Product and Investment Demand
• Recall that investment refers to the purchase of new capital equipment by the private sector
• Firms are profit maximizers and, hence, only take actions that increase firm value (present value of lifetime earnings)
• Therefore a firm will only buy a new piece of capital when the contribution of that capital to firm value is greater that its costP(k) > PV(MPK)
www.StudsPlanet.com
![Page 94: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/94.jpg)
A Numerical example
• Suppose that the current interest rate is 5% and that the cost of a unit of machinery is $100. Capital is assumed to depreciate at a rate of 10% per year.
www.StudsPlanet.com
![Page 95: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/95.jpg)
A Numerical example
• Suppose that the current interest rate is 5% and that the cost of a unit of machinery is $100.
• Given the technology from the previous slide, the marginal product of the first unit of capital is $25/yr. Income stream will this capital generate?
• Year 1: $25
Year 2: $25(1-.10) = $22.50
Year 3: $25(1-.10)(1-.10) = $20.25
Year 3: $25(1-.10)(1-.10)(1-.10) = $18.23 …………
www.StudsPlanet.com
![Page 96: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/96.jpg)
A Numerical example
• What is the present value of this income stream?
www.StudsPlanet.com
![Page 97: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/97.jpg)
A Numerical example
• What is the present value of this income stream?
PV = $25/(1.05) + $22.50/(1.05)^2 + $20.25/(1.05)^3 + …….
www.StudsPlanet.com
![Page 98: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/98.jpg)
A Numerical example
• What is the present value of this income stream?
PV = $25/(1.05) + $22.50/(1.05)^2 + $20.25/(1.05)^3 + …….
PV = $25/( i + depreciation ) = $25/(.15) = $167
• Is this a positive NPV project? Yes ( $167 > $100)
www.StudsPlanet.com
![Page 99: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/99.jpg)
A Numerical example
• What is the present value of this income stream?
PV = $25/(1.05) + $22.50/(1.05)^2 + $20.25/(1.05)^3 + …….
PV = $25/( i + depreciation ) = $25/(.15) = $167
• Is this a positive NPV project? Yes ( $167 > $100)• In fact, solving the above expression tells us that this is a positive NPV
project for any interest rate under
i = (MPK/Pk) – depreciation = ($25/$100) - .10 = .15 = 15%
www.StudsPlanet.com
![Page 100: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/100.jpg)
Interest rates and Investment
0
2
4
6
8
10
12
14
16
0 1 2 3 4 5 6 7
www.StudsPlanet.com
![Page 101: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/101.jpg)
Interest rates and investment
• Note that once the first unit of capital has been purchased, the second unit of capital only has a marginal product of 20.
• Therefore, for this unit of capital to be a positive PV project, the interest rate must be lower than 20/100 - .10 = .1 = 10%
www.StudsPlanet.com
![Page 102: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/102.jpg)
Interest rates and Investment
0
2
4
6
8
10
12
14
16
0 1 2 3 4 5 6 7
www.StudsPlanet.com
![Page 103: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/103.jpg)
Interest rates and Investment
0
2
4
6
8
10
12
14
16
0 1 2 3 4 5
www.StudsPlanet.com
![Page 104: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/104.jpg)
Interest rates and investment
• Diminishing marginal product of Capital guarantees that the demand for investment is downward sloping (increasing rates of investment require lower interest rates)
• To get the total demand for loans, multiply the investment curve by the price of capital)
www.StudsPlanet.com
![Page 105: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/105.jpg)
Interest rates and Investment
0
2
4
6
8
10
12
14
16
0 100 200 300 400 500
www.StudsPlanet.com
![Page 106: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/106.jpg)
Investment Demand
• It is assumed that labor and capital are compliments. That is, when employment rises, the productivity of capital increases as well.
www.StudsPlanet.com
![Page 107: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/107.jpg)
Investment Demand
• It is assumed that labor and capital are compliments. That is, when employment rises, the productivity of capital increases as well.
• Therefore, as a rise in employment should increase the demand for capital and, hence, the demand for loans
www.StudsPlanet.com
![Page 108: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/108.jpg)
Investment Demand
• It is assumed that labor and capital are compliments. That is, when employment rises, the productivity of capital increases as well.
• Therefore, as a rise in employment should increase the demand for capital and, hence, the demand for loans
• Further, any technological improvement should also raise the demand for investment
www.StudsPlanet.com
![Page 109: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/109.jpg)
A rise in investment demand
0
2
4
6
8
10
12
14
16
0 100 200 300 400 500
www.StudsPlanet.com
![Page 110: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/110.jpg)
A rise in investment demand
0
5
10
15
20
25
0 100 200 300 400 500
www.StudsPlanet.com
![Page 111: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/111.jpg)
Capital Market Equilibrium
• For now, assume that there is no government and the US is a closed economy
• Add up individual firm’s hiring decisions to get aggregate investment
• Add up individual household decisions to get aggregate savings
• A capital market equilibrium is an interest rate that clears the market (i.e.,savings equals investment)
• Here, i*= 10%, S* = I*= 300
0
4
8
12
16
20
0 100 200 300 400 500
www.StudsPlanet.com
![Page 112: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/112.jpg)
Example: Post-war Germany
• It is estimated that 20-25% of Germany’s capital stock was destroyed during WWII. How would the German capital market respond to this?
0
4
8
12
16
20
0 100 200 300 400 500
www.StudsPlanet.com
![Page 113: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/113.jpg)
Example: Post-war Germany
• It is estimated that 20-25% of Germany’s capital stock was destroyed during WWII. How would the German capital market respond to this?
• A lower capital stock decreases increases the productivity of new investment and, thus increases investment demand
0
4
8
12
16
20
24
0 100 200 300 400 500
www.StudsPlanet.com
![Page 114: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/114.jpg)
Example: Post-war Germany
• It is estimated that 20-25% of Germany’s capital stock was destroyed during WWII. How would the German capital market respond to this?
• A lower capital stock decreases increases the productivity of new investment and, thus increases investment demand
• The resulting higher equilibrium has a higher interest rate, higher savings and investment 0
4
8
12
16
20
24
0 100 200 300 400 500
www.StudsPlanet.com
![Page 115: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/115.jpg)
Example:The Bubonic Plague
• The Bubonic Plague, or “Black Death” ravaged Europe in the 1300’s. From 1347-1352, approximately 30% of the population in Europe was killed (25 million). What impact will this have on capital markets?
0
4
8
12
16
20
0 100 200 300 400 500
www.StudsPlanet.com
![Page 116: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/116.jpg)
Example:The Bubonic Plague
• The Bubonic Plague, or “Black Death” ravaged Europe in the 1300’s. From 1347-1352, approximately 30% of the population in Europe was killed (25 million). What impact will this have on capital markets?
• A decrease in employment lowers the productivity of investment (labor and capital are complements) and, hence, investment demand
0
4
8
12
16
20
0 100 200 300 400 500
www.StudsPlanet.com
![Page 117: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/117.jpg)
Example:The Bubonic Plague
• The Bubonic Plague, or “Black Death” ravaged Europe in the 1300’s. From 1347-1352, approximately 30% of the population in Europe was killed (25 million). What impact will this have on capital markets?
• A decrease in employment lowers the productivity of investment (labor and capital are complements) and, hence, investment demand
• The result: lower interest rates, savings, and investment
0
4
8
12
16
20
0 100 200 300 400 500
www.StudsPlanet.com
![Page 118: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/118.jpg)
Temporary vs. Permanent Shocks
• Unlike labor markets, the timing and persistence of productivity shock are important
0
4
8
12
16
20
0 100 200 300 400 500
www.StudsPlanet.com
![Page 119: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/119.jpg)
Temporary vs. Permanent Shocks
• Unlike labor markets, the timing and persistence of productivity shock are important
• New capital takes time to install. Therefore, productivity improvements must be long lasting to effect investment demand
0
4
8
12
16
20
0 100 200 300 400 500
www.StudsPlanet.com
![Page 120: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/120.jpg)
Temporary vs. Permanent Shocks
• Unlike labor markets, the timing and persistence of productivity shock are important
• New capital takes time to install. Therefore, productivity improvements must be long lasting to effect investment demand
• A temporary improvement in productivity will increase savings (as consumers smooth this extra income), but have no impact on investment
0
4
8
12
16
20
0 100 200 300 400 500
www.StudsPlanet.com
![Page 121: Capital markets](https://reader036.vdocuments.us/reader036/viewer/2022062307/5568c4d6d8b42a7c7d8b51b4/html5/thumbnails/121.jpg)
Temporary vs. Permanent Shocks
• Unlike labor markets, the timing and persistence of productivity shock are important
• New capital takes time to install. Therefore, productivity improvements must be long lasting to effect investment demand
• On the other hand, a permanent technological improvement will increase investment, but have little impact on savings 0
4
8
12
16
20
24
0 100 200 300 400 500
www.StudsPlanet.com