What you will learn
in this Module:
222 section 5 The Financial Sector
- The relationship between
savings and investment
spending - The purpose of the four
principal types of financial
assets: stocks, bonds, loans,
and bank deposits - How financial intermediaries
help investors achieve
diversification
Module 22
Saving, Investment, and
the Financial System
Matching Up Savings and Investment Spending
Two instrumental sources of economic growth are increases in the skills and knowl-
edge of the workforce, known as human capital,and increases in capital—goods used to
make other goods—which can also be called physical capitalto distinguish it from
human capital.Human capital is largely provided by the government through public
education. (In countries with a large private education sector, like the United States,
private post-secondary education is also an important source of human capital.) But
physical capital, with the exception of infrastructure such as roads and bridges, is
mainly created through private investment spending—that is, spending by firms rather
than by the government.
Who pays for private investment spending? In some cases it’s the people or corpora-
tions who actually do the spending—for example, a family that owns a business might
use its own savings to buy new equipment or a new building, or a corporation might
reinvest some of its own profits to build a new factory. In the modern economy, how-
ever, individuals and firms who create physical capital often do it with other people’s
money—money that they borrow or raise by selling stock. If they borrow money to cre-
ate physical capital, they are charged an interest rate. The interest rateis the price, cal-
culated as a percentage of the amount borrowed, charged by lenders to borrowers for
the use of their savings for one year.
To understand how investment spending is financed, we need to look first at how
savings and investment spending are related for the economy as a whole.The Savings– Investment Spending Identity
The most basic point to understand about savings and investment spending is that
they are always equal. This is not a theory; it’s a fact of accounting called the savings–
investment spending identity.
To see why the savings– investment spending identity must be true, first imagine a
highly simplified economy in which there is no government and no interaction withTheinterest rateis the price, calculated as
a percentage of the amount borrowed,
charged by lenders to borrowers for the use
of their savings for one year.
According to the savings–investment
spending identity,savings and investment
spending are always equal for the economy
as a whole.