Financial Intermediation and the Great Recession

Introduction

• Date & Event: September 15th, 2008 - Lehman Brothers bankruptcy.
• Significance: Marked the beginning of the worst economic downturn since the Great Depression.
• Key Concept: The reduced efficacy of financial intermediation.

Importance of Financial Intermediation

• Financial Intermediaries: Bridge gap between savers and borrowers.
• Market for Loanable Funds: Platform where savings supply meets borrowing demand.

Borrowing and Saving

• Life Income Patterns:
  • Income fluctuates predictably over a lifetime.
  • Young age: Low income, initial jobs.
  • Prime working years: Higher income, potential savings.
  • Retirement: Lower income, reliance on savings.
• Consumption Without Savings:
  • Struggles during youth and retirement.
  • Immediate consumption in prime years without savings leads to lower retirement funds.

Life Cycle Theory of Savings

• Cycle: Borrow when young, save during prime years, dis-save during retirement.
• Deviations: Individual differences in consumption and savings behavior.

Time Preference and Behavioral Economics

• Time Preference: Impatience vs. patience in saving/borrowing.
• Behavioral Economics: Importance of nudges (e.g., automatic enrollment in retirement plans).

Borrowing for Investment

• Education and Business: Students and entrepreneurs often borrow for big investments.
• Example: Howard Schultz and Starbucks.

Market for Loanable Funds

• Analysis Tool: Supply and demand framework.
• Interest Rate: Price of saving and borrowing.
• Supply Curve: Higher interest rates increase savings supply.
• Demand Curve: Lower interest rates increase borrowing demand.

Shifts in Supply and Demand

• Supply Increase: More savings shift supply outward, reducing interest rates (e.g., South Korea, China).
• Demand Changes:
  • Decreased optimism shifts demand inward, lowering interest rates.
  • Investment tax credits shift demand outward, increasing interest rates.

Conclusion

• Multiple Markets: Various types for different borrowers/lenders, e.g., banks, bond markets, stock markets.
• Upcoming Topics: Financial intermediaries and their importance.

Additional Resources

• Practice: Click Practice Questions.
• Next Steps: Go to the Next Video on MRUniversity.com.