KW_Macro_Ch_09_Sec_02_The_Financial_System - chapter 9 >...

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>> Savings, Investment Spending, and the Financial System Section 2: The Financial System chapter 9 A well-functioning financial system that brought together the funds of British, French, and other international investors made the Chunnel possible. But to think that this is an exclusively modern phenomenon is misguided. Financial markets raised the funds that were used to develop colonial markets in India, to build canals across Europe, and to finance the Napoleonic wars in the eighteenth century. Capital inflows financed the early economic development of the United States, funding investment spending in mining, railroads, and canals. In fact, many of the principal features of financial markets and assets have been well understood in Europe and the United States since the eighteenth century. However, these features are no less rele- vant today. So let’s begin by understanding exactly what is traded in financial markets. Financial markets are where households invest their current savings and their accu- mulated savings, or wealth, by purchasing financial assets . A financial asset is a paper claim that entitles the buyer to future income from the seller. For example, when a saver lends funds to a company, the loan is a financial asset sold by the company that A household’s wealth is the value of its accumulated savings. A financial asset is a paper claim that entitles the buyer to future income from the seller.
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entitles the lender (the buyer) to future income from the company. A household can also invest its current savings or wealth by purchasing a physical asset, a claim on a tangible object, such as a preexisting house or pre-existing piece of equipment. It gives the owner the right to dispose of the object as he or she wishes (for example, rent it or sell it). The purchase of a financial or physical asset is typically called investing. So if you purchase a preexisting piece of equipment—say, a used airliner—you are engaging in investing in a physical asset. But if you spend funds that add to the stock of physi- cal capital in the economy—say, purchasing a newly manufactured airplane—you are engaging in investment spending. If you were to go to your local bank and get a loan—say, to buy a new car—you and the bank would be creating a financial asset—your loan. A loan is one important kind of financial asset in the real world, one that is owned by the lender—in this case, your local bank. In creating that loan, you and the bank would also be creating a liability, a requirement to pay income in the future. So although your loan is a financial asset from the bank’s point of view, it is a liability from your point of view: a requirement that you repay the loan, including any interest. In addition to loans, there are three other important kinds of financial assets: stocks, bonds, and bank deposits . Because a financial asset is a claim to future income that someone has to pay, it is also someone else’s liability. We’ll explain in detail shortly who bears the liability for each type of
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This note was uploaded on 04/10/2008 for the course ECONOMICS 103 taught by Professor Sheflin during the Spring '08 term at Rutgers.

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KW_Macro_Ch_09_Sec_02_The_Financial_System - chapter 9 >...

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