Ch. 13 Reflection: Savings, Investment and the Financial System

Ch. 13 Reflection

            There are many factors that affect our government deficit, interest rates for loans, and public saving habits. Chapter 13, Saving, Investment and the Financial System, goes into a lot of these issues and solutions. Public saving provides banks with money to loan to the public for investment in capital infrastructure such as the purchase of real estate or manufacturing equipment. The more that the public saves the more banks have to loan. When the stock market and interest rates on saving is high, the public saves more, thus creating more low interest loans for capital improvements. However, when the stock market performs poorly or when savings interest rates are minimal, the public saves less and less financial capital is available to loan, which sometimes correlates to higher interest rates on loans. 

            If the government taxes interest gained from public savings in the form of stock market profits and savings account interest, then the public tends to save less. When these taxes are removed the public saves more. If the government wants to stimulate public saving, it is best to incentivize saving through low or no taxes on savings interest and gains. When the government has a budget deficit, the government has to borrow from different banks and financial institutions which competes with capital available for investment by the public and increases interest rates on those loans. It is generally better for the economy if the government doesn’t carry a deficit, because more capital will be made available to the public for investment with lower interest rates. 
            With the record breaking budget deficits experienced today on the national and state level, we can witness a phenomenon called crowding out, which is a “decrease in investment that results from government borrowing” as described above. Crowding out can be a concern, especially when governments such as ours carry a large deficit. However, governments and large established corporations are able to sell bonds to the general public as a means of raising capital that the public is not able to do, this is one strategy to limiting the effect of crowding out. Instead the public is usually limited to loans from banks and credit unions for capital investment. However, the public is able to find equity investors for business investment that share future profits with the investor in a way that governments are not able to. Startups often use this sort of fund raising model to grow their companies.

            One strategy that banks use to increase their available capital to loan, which is not discussed in this chapter, is the fractional reserve banking system. This allows banks to loan more money than they have on hand. Instead banks are only required to keep a “fraction” of the money around to secure the loans and are betting that they can meet the needs of customer’s withdrawal habits with future loan payments. I have learned that in most cases a bank only has to keep 10% of the money to secure the loan. This becomes a major issue when there is a run on the banks in which many customers want to withdraw large amounts of their savings at once. Some banks are insured for this reason. I hope that we get to learn more about and discuss the fractional reserve banking system in future chapters. 

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