Events that occur within the financial system are central to understanding developments in the overall economy. As we have just seen, the institutions that make up this system-the bond market, the stock market, banks, and mutual funds-have the role of coordinating the economy’s saving and investment. And as we saw in the previous chapter, saving and investment are important determinants of long-run growth in GDP and living standards. As a result, macro economists need to understand how financial markets work and how various events and policies affect them. As a starting point for an analysis of financial markets, we discuss in this section the key macroeconomic variables that measure activity in these markets. Our emphasis here is not on behavior but on accounting. Accounting refers to how various numbers are defined and added up. A personal accountant might help an individual add up his income and expenses. A national income accountant does the same thing for the economy as a whole. The national income accounts include, in particular, GDP and the many related statistics. The rules of national income accounting include several important identities. Recall that an identity is an equation that must be true because of the way the variables in the equation are defined. Identities are useful to keep in mind, for they clarify how different variables are related to one another. Here we consider some accounting identities that shed light on the macroeconomic role of financial markets .

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