1
00:00:00,555 --> 00:00:03,555
♪ [music] ♪

2
00:00:14,300 --> 00:00:19,440
[Alex] On September 15, 2008,

3
00:00:19,440 --> 00:00:21,780
the world's financial system
was shaken to its core

4
00:00:21,780 --> 00:00:24,780
when the investment bank,
Lehman Brothers,

5
00:00:24,780 --> 00:00:27,080
filed for bankruptcy.

6
00:00:27,080 --> 00:00:30,080
The impact was great not simply
because Lehman was big,

7
00:00:30,080 --> 00:00:36,240
but also because it was
an important financial intermediary,

8
00:00:36,240 --> 00:00:37,240
an institution that
helps bridge the gap

9
00:00:37,240 --> 00:00:38,700
between savers and borrowers.

10
00:00:38,700 --> 00:00:41,700
The failure of Lehman marked
the beginning of a series of events

11
00:00:41,700 --> 00:00:46,970
that signaled
the worst economic downturn

12
00:00:46,970 --> 00:00:49,060
since the Great Depression.

13
00:00:49,060 --> 00:00:50,060
And while there's several
significant angles

14
00:00:50,060 --> 00:00:52,060
to the Great Recession,

15
00:00:52,060 --> 00:00:53,060
one of them was
the decreased efficacy

16
00:00:53,060 --> 00:00:55,290
of financial intermediation.

17
00:00:55,290 --> 00:00:56,840
Now, some later videos
are going to go through this

18
00:00:56,840 --> 00:00:59,840
in more detail.

19
00:00:59,840 --> 00:01:03,840
But for now, we want to start
with some basic observations

20
00:01:03,840 --> 00:01:08,620
as to why financial intermediation
is so important.

21
00:01:08,620 --> 00:01:12,980
We'll start
with the supply of savings

22
00:01:16,025 --> 00:01:17,770
and the demand to borrow,

23
00:01:17,770 --> 00:01:18,770
and the market
which brings them together,

24
00:01:18,770 --> 00:01:20,770
the Market for

25
00:01:20,770 --> 00:01:26,430
So why do people borrow
and save at all?

26
00:01:26,430 --> 00:01:31,580
Well, let's imagine a world
without borrowing and saving.

27
00:01:31,580 --> 00:01:37,610
Most people's incomes
don't stay flat their entire lives.

28
00:01:37,610 --> 00:01:39,220
They change in predictable ways.

29
00:01:39,220 --> 00:01:40,220
Here's a typical pattern,

30
00:01:40,220 --> 00:01:41,220
showing a person's income
over their life,

31
00:01:41,220 --> 00:01:42,220
with their income
on the vertical axis

32
00:01:42,220 --> 00:01:46,820
and time on the horizontal axis.

33
00:01:46,820 --> 00:01:49,440
When you're young
and still in school,

34
00:01:49,440 --> 00:01:50,440
you might make
a little bit of money,

35
00:01:50,440 --> 00:01:52,440
waiting tables
or occasionally mowing lawns.

36
00:01:52,440 --> 00:01:56,250
Your first job out of school,
it's going to pay more,

37
00:01:56,250 --> 00:01:58,170
and after a few years
of experience

38
00:01:58,170 --> 00:01:59,170
and hopefully
a few raises along the way,

39
00:01:59,170 --> 00:02:01,170
you make more than you ever have.

40
00:02:01,170 --> 00:02:05,630
Then, as you age,
you look forward to retirement,

41
00:02:05,630 --> 00:02:07,500
when your income falls.

42
00:02:07,500 --> 00:02:08,500
But you're no longer working

43
00:02:08,500 --> 00:02:10,500
and you could really enjoy 
your golden years.

44
00:02:10,500 --> 00:02:13,090
[Estelle from “Seinfeld” TV series] 
“We're moving to Florida!”

45
00:02:13,090 --> 00:02:16,390
[George] “What?
You're moving to Florida?

46
00:02:16,390 --> 00:02:19,390
Ah-hah! That's wonderful!
I'm so happy!

47
00:02:19,390 --> 00:02:23,370
For you! I'm so happy for you!”

48
00:02:23,370 --> 00:02:26,720
[Alex] Now, let's imagine

49
00:02:26,720 --> 00:02:29,720
if your consumption followed
the same path as your income

50
00:02:29,720 --> 00:02:35,140
and you never saved or borrowed.

51
00:02:35,140 --> 00:02:36,930
You'd struggle when young,

52
00:02:36,930 --> 00:02:39,930
and you'd be unable
to invest in an education.

53
00:02:39,930 --> 00:02:42,490
Then, you'd spend
every cent you make

54
00:02:42,490 --> 00:02:45,490
during your prime working years.

55
00:02:45,490 --> 00:02:47,910
Well, that sounds
like a lot of fun.

56
00:02:47,910 --> 00:02:48,910
But without savings,
your income will drop suddenly

57
00:02:48,910 --> 00:02:50,910
when you retire,
and so will your consumption.

58
00:02:50,910 --> 00:02:52,500
Your golden years
wouldn't be so golden.

59
00:02:52,500 --> 00:02:53,476
[Doug from “King of Queens” TV series]

60
00:02:53,476 --> 00:02:54,453
[Kevin] If you're so smart,

61
00:02:54,453 --> 00:02:55,430
why don't you tell them that 
you live in my basement?

62
00:02:55,430 --> 00:02:56,900
[Arthur] Why don't you tell them 
you're enormous?

63
00:02:56,900 --> 00:02:57,900
[Doug] Why don't you tell them

64
00:02:57,900 --> 00:03:00,570
that your total salary
last year was $12?

65
00:03:00,570 --> 00:03:03,730
[Arthur] That was after taxes.

66
00:03:03,730 --> 00:03:07,990
[Alex] So instead,
people tend to follow

67
00:03:07,990 --> 00:03:10,990
a life cycle theory of savings.

68
00:03:10,990 --> 00:03:17,960
A person can start out consuming
more than she makes,

69
00:03:17,960 --> 00:03:20,620
borrowing to fill that gap --

70
00:03:20,620 --> 00:03:21,620
and to pay for things
like an education.

71
00:03:21,620 --> 00:03:23,620
Then, during
her prime working years,

72
00:03:23,620 --> 00:03:27,470
she makes more than she consumes,
paying down her debt

73
00:03:27,470 --> 00:03:30,470
and saving the extra income
for retirement.

74
00:03:30,470 --> 00:03:36,600
And when retirement comes,
she can spend those savings

75
00:03:36,600 --> 00:03:38,860
and enjoy the golden years
even without working.

76
00:03:38,860 --> 00:03:41,860
Now of course, many people
deviate from this exact path,

77
00:03:41,860 --> 00:03:43,690
depending on details.

78
00:03:43,690 --> 00:03:47,310
Most people, for example,
they consume less in college

79
00:03:47,310 --> 00:03:50,860
than they do as professionals.

80
00:03:50,860 --> 00:03:53,860
Ramen noodles are no longer
a staple of my diet.

81
00:03:53,860 --> 00:04:02,250
But generally speaking,
many people follow a pattern

82
00:04:02,250 --> 00:04:04,100
of borrowing, saving,
and dissaving

83
00:04:04,100 --> 00:04:05,100
to smooth their consumption path
over their lifetime.

84
00:04:05,100 --> 00:04:07,100
Of course, just like some people
can't wait until after dinner

85
00:04:07,100 --> 00:04:11,720
to reach for that cookie jar,

86
00:04:11,720 --> 00:04:16,800
not everyone saves and spends
in the same way.

87
00:04:16,800 --> 00:04:19,250
How much you save and borrow
depends upon your time preference.

88
00:04:19,250 --> 00:04:20,250
Some people -- they're more
impatient than others.

89
00:04:20,250 --> 00:04:22,250
We all know someone
who spends everything they've got

90
00:04:22,250 --> 00:04:27,050
and doesn't save enough.

91
00:04:27,050 --> 00:04:28,420
On the other hand,
if you're keeping to a budget

92
00:04:28,420 --> 00:04:31,420
and not spending too much
so that you can go to college,

93
00:04:31,420 --> 00:04:35,640
well that's an example
of being patient

94
00:04:35,640 --> 00:04:38,640
and waiting
for higher consumption later.

95
00:04:38,640 --> 00:04:42,800
We've also learned
from behavioral economics

96
00:04:42,800 --> 00:04:49,520
that saving is not just a matter
of weighing costs and benefits.

97
00:04:49,520 --> 00:04:52,330
Nudges can matter.

98
00:04:52,330 --> 00:04:55,330
If your employer automatically
enrolls you in a retirement plan,

99
00:04:55,330 --> 00:04:56,870
or sets a high
default contribution rate,

100
00:04:56,870 --> 00:04:57,870
you'll probably end up saving more

101
00:04:57,870 --> 00:04:59,870
than if you have to choose yourself,

102
00:04:59,870 --> 00:05:02,070
even if choosing yourself
would only take a few hours of work

103
00:05:02,070 --> 00:05:05,070
once in your lifetime.

104
00:05:05,070 --> 00:05:10,360
Another important reason to borrow
is to make big investments.

105
00:05:10,360 --> 00:05:13,370
Just as students borrow
to invest in education,

106
00:05:13,370 --> 00:05:16,370
businesses borrow
to invest in big projects.

107
00:05:16,370 --> 00:05:18,950
Entrepreneurs with great ideas
but not much money,

108
00:05:18,950 --> 00:05:21,950
they may have to borrow
or sell a stake in their idea

109
00:05:21,950 --> 00:05:27,450
just to get their venture
off the ground.

110
00:05:27,450 --> 00:05:30,280
For example, Howard Schultz
built Starbucks into a global brand

111
00:05:30,280 --> 00:05:33,280
by borrowing and raising capital

112
00:05:33,280 --> 00:05:36,690
through several different types
of financial intermediaries.

113
00:05:36,690 --> 00:05:39,690
We'll talk more about that
in upcoming videos.

114
00:05:39,690 --> 00:05:40,690
As with any other good,

115
00:05:40,690 --> 00:05:43,660
we're going to use
supply and demand

116
00:05:43,660 --> 00:05:45,140
to analyze the market
for saving and borrowing,

117
00:05:45,140 --> 00:05:48,140
known as the Market
for Loanable Funds.

118
00:05:48,140 --> 00:05:49,800
As we've seen, there are
lots of good reasons

119
00:05:49,800 --> 00:05:52,800
to save and to borrow.

120
00:05:52,800 --> 00:05:57,650
But we have failed to mention
one big factor -- price.

121
00:05:57,650 --> 00:06:00,650
What's the price
of saving and borrowing?

122
00:06:00,650 --> 00:06:03,660
It's the interest rate.

123
00:06:03,660 --> 00:06:06,660
So here's the supply curve
showing the supply of savings.

124
00:06:06,660 --> 00:06:09,110
As the interest rate goes up,

125
00:06:09,110 --> 00:06:12,110
the quantity
of savings supplied increases,

126
00:06:12,110 --> 00:06:18,010
and here's the demand curve
showing the demand to borrow.

127
00:06:18,010 --> 00:06:21,500
Lower interest rates
incentivize borrowing,

128
00:06:21,500 --> 00:06:22,500
so as the interest rate falls,

129
00:06:22,500 --> 00:06:24,500
the quantity
of borrowing demanded increases.

130
00:06:24,500 --> 00:06:27,560
As with any other
supply and demand graph,

131
00:06:27,560 --> 00:06:30,560
different factors
will shift the curves.

132
00:06:30,560 --> 00:06:31,930
If a lot of people decide
that it'd be a good idea

133
00:06:31,930 --> 00:06:34,930
to increase their savings,
for example,

134
00:06:34,930 --> 00:06:40,070
then the supply of savings
will shift outward.

135
00:06:40,070 --> 00:06:45,300
As you can see, this would
cause interest rates to fall.

136
00:06:45,300 --> 00:06:46,300
This is what we saw in countries
like South Korea and China,

137
00:06:46,300 --> 00:06:48,080
as their populations saved more.

138
00:06:48,080 --> 00:06:51,060
On the demand side,
if investors, say

139
00:06:51,060 --> 00:06:54,060
became less optimistic
for some reason,

140
00:06:54,060 --> 00:06:57,820
the demand to borrow
would shift inward,

141
00:06:57,820 --> 00:07:00,820
causing the interest rate to fall.

142
00:07:00,820 --> 00:07:02,720
But if, say an investment tax credit
from the government

143
00:07:02,720 --> 00:07:05,720
increased the demand to invest,

144
00:07:05,720 --> 00:07:09,720
then the demand curve will shift
in the opposite direction,

145
00:07:09,720 --> 00:07:12,050
up and to the right,
pushing interest rates up.

146
00:07:12,050 --> 00:07:16,790
Thinking about the Market
for Loanable Funds helps us

147
00:07:16,790 --> 00:07:21,430
to see the big picture
and understand the raw factors

148
00:07:21,430 --> 00:07:23,390
that determine interest rates

149
00:07:23,390 --> 00:07:24,390
and the quantity
of borrowing and lending.

150
00:07:24,390 --> 00:07:26,980
But there isn't actually
one market

151
00:07:26,980 --> 00:07:29,570
called the Market
for Loanable Funds.

152
00:07:29,570 --> 00:07:32,160
It's not like the New York
Stock Exchange.

153
00:07:32,160 --> 00:07:34,660
Instead, there are many,
many, many markets

154
00:07:34,660 --> 00:07:37,660
for different kinds of borrowers
and different kinds of lenders.

155
00:07:37,660 --> 00:07:42,190
And there are different types
of institutions like banks,

156
00:07:42,190 --> 00:07:44,180
bond markets, and stock markets

157
00:07:44,180 --> 00:07:47,180
that connect
the two sides of the market.

158
00:07:47,180 --> 00:07:51,000
We're going to delve more deeply

159
00:07:51,530 --> 00:07:54,530
into the different kinds
of financial intermediaries,

160
00:07:54,530 --> 00:07:57,000
[Narrator] If you want
to test yourself,

161
00:07:57,000 --> 00:08:00,000
click "Practice Questions."

162
00:08:00,000 --> 00:08:01,800
Or, if you're ready to move on,

163
00:08:01,800 --> 00:08:04,800
you can click 
"Go to the Next Video."

164
00:08:04,800 --> 00:08:12,000
You can also visit MRUniversity.com

165
99:59:59,999 --> 99:59:59,999
to see our entire library
of videos and resources.

166
99:59:59,999 --> 99:59:59,999
♪ [music] ♪