There is a distinction between real and nominal interest rates.
The real rate of interest is only 1 percent if the nominal interest rate is 10 percent and inflation is 9 percent.
A firm makes its investment decisions by comparing its expected real net return from investment projects to the real rate of interest.
Real interest rates are not the same as nominal interest rates.
They purchased homes in record numbers, even though they had to borrow money at high interest rates.
Buyers were willing to borrow at such high rates because they believed that prices in California would continue to rise.
If housing prices rose by 12 percent a year, they would earn a 2 percent annual return because their mortgage loans were just 10 percent.
The real interest rate on the money would be -2 percent.
The housing boom in California ended when housing prices stopped rising at such high rates.
There is a correlation between the stock market and investment spending.
Investment spending tends to be high when the stock market is high.
It makes sense that the two are related.
When financing a new project, consider the firm's options.
New shares can be issued and sold.
The more shares the firm needs to sell, the higher the share price is.
A corporation sells a bond to the public in order to raise money.
High stock prices lead to high investment.
The theory of investment is related to the University.
Investment spending to stock prices was high in the late 1990s.
The stock market and investment spending appeared to be more closely linked than in the past.
From 1997 to 2000 the stock market and investment spending rose sharply.
The stock market plunged, investment spending fell, and the economy entered a recession.
This is a typical pattern.
The stock market and investment spending have risen and fallen together.
The reason the two were so close was that investors were too optimistic about the future.
They believed that the economic prosperity would last forever because of new technology.
Stock prices were high because investors had high expectations for future dividends.
Firms rushed to make huge investments in the fiber-optics and telecommunications industries.
Observers wondered if the expectations were rational.
There was enough optimism to drive up prices.
In many cases, the stock prices of companies that had never turned a profit were still very high.
In the aftermath of the Great Recession, the speed of economic recovery depended on providing assistance to underwater homeowners.
They found that in the face of housing price declines, households with the largest debt burdens cut their spending more than households with lower debt burdens.
Total consumption spending was reduced in the economy by not providing enough assistance to those homeowners.
Rather than focusing on saving the banks, policymakers should have focused on homeowners.
Policymakers tried a variety of programs to assist home buyers, but they proved to be controversial and difficult to fall in line with.
Many people objected to helping people who had too much debt on their homes and were worried about what would happen to their home.
If debts were routinely forgiven, these homeowners are in the future.
The majority of Sufi argue that this reluctance came at a severe cost to the underwater homeowners who were making their mortgage payments.
Exercise 4.5 is related to it.
The economy did well in the late 1990s, but it couldn't grow at those rates forever.
Many investors and firms thought it could.
The stock market plummeted when they realized it couldn't.
The stock market's rise and fall were linked by optimism and pessimism about the economy.
The stock market mirrored expectations about the economy held by firms and individual investors, rather than causing the rise and fall of investment spending.
Financial Households save and invest for different reasons.
Investment can be made through a typical couple intermediation.
If they have a financial emergency.
It's possible to convert money on short to money on long for households because they can be withdrawn notice.
Firms and business managers are usually risk-takers.
They are betting that their vision of the future will come true and make a lot of money.
These investors need money for a long time.
It takes years before the business begins to produce profits.
Entrepreneurs would have to get funds from individual Savers.
They would have to negotiate with a lot of people.
This would take a lot of time and money.
Savers would face high risks if they lent all their money to a single person who had a risky project.
It would not be easy to monitor the investor's decisions if all their funds were tied up in a single project.
Their invest ments wouldn't be liquid.
Entrepreneurs would have to pay high interest rates in order to compensate for the risk they would be taking, but higher interest rates would make it hard for them to make a profit.
No one would invest in the project if there was no prospect of profits.
Society wouldn't be able to turn its savings into profitable investment projects.
The answer is through financial advisers.
Money from mutual funds and other types of financial institutions is given to organizations.
These institutions channel funds into investors.
Local banks accept deposits from savers and use the funds to make loans to local businesses.
Deposits in savings accounts can be used to make loans for housing.
In exchange for the protection provided by the insurance payments, insurance companies accept premium payments from individuals.
Insurance companies lend the premiums received to earn returns from investments so they can pay off the insurance claims of individuals.
The costs of negotiation are reduced by pooling the funds of savers.
Most individual investors don't have the expertise to evaluate and monitor investments.
To some degree, these financial institutions provide liquid funds.
In normal circumstances, financial intermediaries can lend out most of the money and still have enough on hand to meet the deposits of households who withdraw their money at the same time.
They do this by not putting all the eggs in one basket.
Intermediaries make loans in a number of projects whose returns are uncertain.
Each project can pay a return either higher or lower than 8 percent.
Those with higher returns will likely offset those with lower returns as long as the returns are inde pendent of one another.
As a group, the projects will earn 8 percent if the bank invests in a large number of them.
Financial advisers reduce risks in related ways.
A fire insurance company accepts premiums from many individuals in communities throughout the country and uses the funds to make investments.
Because not all houses will burn down in the same year, the insurance company knows it will have a stable source of funds.
Insurance can be diversified if events are independent of one another.
Some situations can't be insured by the same company.
An insurance company wouldn't be wise to provide earthquake insurance for just the Los Angeles area.
The firm would have to make payments to clients who suffered loss without anyone else's help.
Bank loans are not fully independent.
Many firms will have trouble meeting their loan obligations during a recession.
Financial intermediation has seen an innovation in recent years.
If a savings and loan company made a loan to a home purchaser, it would hold onto the loan until it was paid off.
If the savings and loan were able to attract new deposits, they could make new loans.
Fannie Mae and Freddie Mac changed the way mortgage markets worked.
They packaged and sold mortgages from savings and loans throughout the country to investors in the financial market.
This enabled savings and loans to offer addi tional mortgages with the funds they received from Fannie Mae or Freddie Mac, and it allowed investors to own a part of a diversified collection of mortgages from around the country.
The private sector followed suit.
Credit card repackaging, and selling them to the consumer, are just some of the types of financial obligations that are now covered by the practice of purchasing loans.
Financial markets can be used to borrow money.
Borrowing funds to purchase assets.
Sometimes financial intermediation can go wrong.
The economy suffers when it does.
The Great Depression, the U.S. savings and loan crisis, and a similar crisis in Japan are some of the important examples of the failure of financial intermediation.
In the early days of the Great Depression, many banks in the United States provided loans to farmers and businesses that turned out to be unprofitable.
There were rumors that banks would fail.
Austria's Panicky investors panicked after the collapse of Creditanstalt, the largest bank in Austria.
Banking panics occurred in other countries in Europe, including to withdraw their funds from a bank.
Few banks can survive a run because not all deposits are kept on hand.
The bank runs resulted in thousands of healthy Americans.
Many farms and businesses were unable to get loans because of the Great Depression.
The countries with the most severe banking panics were hardest hit by the Depression.
Depositors will be reimbursed for Federal government insurance on deposits up to $250,000 in each account at each bank if their banks fail.
Most countries have some form of deposit insurance.
The U.S. savings and loan crisis was caused by deposit insurance.
Mortgage loans were made to households at low interest rates in the early 1970s.
The nominal interest rates went up as inflation went up.
The savings and loans had to pay high interest rates to attract deposits, but they were earning low interest from the money they had previously lent out.
Many of the S&Ls failed.
broadening the range of investments the industry could make was the government's attempt to assist the savings and loan industry.
S&Ls began aggressively investing in risky projects to earn higher returns.
Depositors knew that their savings were insured by the government.
The government had to bail out the S&Ls at a cost of nearly $100 billion because many of the risky projects failed.
Most people didn't suffer from the collapse of their savings and loan institutions because their savings were insured.
They had to pay the bill as taxpayers.
Japan had similar problems in the 1990s.
The crash in real estate prices led to seven of the eight largest Japanese mortgage lenders going bankrupt.
The Japanese government used taxpayers' funds to bail out the lenders.
The crisis in the newly developed securitization markets was caused by the decline in housing prices.
The basic story is easy to understand.
When borrowers began to miss payments or default on their loans, it caused major disruptions in the market for securitized loans, which in turn, disrupted credit to other sectors in the economy.
The housing decline put Fannie Mae and Freddie Mac under direct government control.
Customers ran to withdraw their funds from financial institutions that they thought were weak.
Merrill Lynch and Wachovia Bank were taken over by other financial institutions as a result of this.
Lehman Brothers' failure set off a panic in the markets that spread to other international banks and financial institutions.
The severity of the crisis and fear that it would lead to a total worldwide financial collapse caused the stock market to plunge.
Businesses were not able to borrow funds to run their businesses on a day-to-day basis as credit became unavailable.
At the height of the crisis, it was nearly impossible for state and local governments to borrow.
Governments around the world took steps to alleviate the crisis.
The activities of central banks during the crisis are described in more detail in the next chapter.
The Troubled Asset Relief Program, or TARP, was passed by the U.S. Congress and allowed the Treasury to use up to $700 billion to shore up the financial system.
The U.S. Treasury used some of the proceeds to provide funds to large banks in order to restore confidence in the financial system and take limited ownership in these banks.
The American International Group, which provided financial insurance to other firms and was deemed essential to keep afloat during the crisis, received funding from the government, as well as Fannie Mae and Freddie Mac.
The United States and other countries around the world increased the limits on the amounts eligible for deposit insurance to bolster consumer confidence in banking institutions.
The Dodd-Frank legislation added a new set of regulatory tools.
Similar actions were taken by other governments.
The system of financial intermediation was under a lot of stress.
Some households were willing to take on debt because they were confident they could make money in the housing market.
Exotic investment securities were offered to investors based on the loans.
Financial institutions bought these securities without knowing what was in them.
The agencies that traditionally evaluated the riskiness of these investments did not post enough warning because the securities were so new.
When the housing boom ended and borrowers stopped making payments, it created panic in the financial market.
New funds for borrowers to enter the housing market were provided by investors and financial firms.
Concerns about the creditworthiness of banks and other financial was hailed as a positive development.
There was a dark side to the way that these securities were held.
Many were going through the process.
As the housing boom began in 2002, the damage from the loans spread to buyers began to take increasing risks.
The financial market was made sub by the lenders.
Financial intermediation does not always work from these examples.
There is a constant debate on whether the government should play a role in investment decisions for the economy.
Some economists and policymakers are looking at the risks in the financial markets.
We dis 3 in this chapter.
Real interest rates affect investment spending.
Financial advisers can pack rates.
Investments provide benefits in the future.
Investment spending is volatile because expectations about the future are uncertain.
All the problems are assignable in MyLab Economics.
Explain why investment spending is a volatile component of GDP.
Proponents of solar consumption are more volatile.
Investment spending moves more than paying high prices for electricity.
Keynes states that optimism and pessimism are related to expenses.
The concept of pres was often irrational.
If you have $500,000, you can purchase an annuity.
The name of the theory is explained.
If you explain both terms in the name of theplier live, you can see if you can get annuity payments of $35,000 per year.
What do you think would happen to the theory?
A large sum and will be paid $200,000 per year for 10 explain why changes in measures of consumer confi years start in year 1.
You can make durable goods.
"2" can be entered in cells A1 through A10.
The Federal Reserve Bank of St. Louis will have the result if you use the Web site for the C3.
You were in a car for two years.
An American company wants to invest in energy- saving years and you are willing to pay them $5,000 a year for 4.
Spreading your payments over technologies will reduce spending in the long term.
If a project costs $100 and takes 1 and 2 years to complete, that's _____.
The present value of investment exceeds its cost if the interest rate is 10 percent.
$300 is equal to 1 year.
Investment spending in the $300 will equal the economy if real interest rates rise.
The present value of a fixed payment decreases when three sources of funds are used to invest in interest rates.
The Q-theory of investment was developed when interest rates fell.
Household A and Household B both have home mortgage rates that are very low by historical standards, but many not.
The effects of individuals not wanting to buy homes is what the research shows.