Having discussed some of the important financial institutions in our economy and the macroeconomic role of these institutions, we are ready to build a model of financial markets. Our purpose in building this model is to explain how financial markets coordinate the economy’s saving and investment. The model also gives us a tool with which we can analyze various government policies that influence saving and investment. To keep things simple, we assume that the economy has only one financial market, called the market for loan able funds. All savers go to this market to deposit their saving, and all borrowers go to this market to get their loans. Thus, the term loan able fond refers to all income that people have chosen to save and lend out, rather than use for their own consumption. In the market for loan able funds, there is one interest rate, which is both the return to saving and the cost of borrowing The assumption of a single financial market, of course, is not literally true.’ As we have seen, the economy has many types of financial institutions. But as we discussed in Chapter 2, the art in building an economic model is simplifying the world in order to explain it. For our purposes here, we can ignore the diversity of financial institutions and assume that the economy has a single financial market.

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