Chapter 28 — Key Takeaways
The loanable funds model
- Supply = saving (slopes up with interest rate)
- Demand = investment + government borrowing (slopes down)
- Equilibrium = real interest rate that equates saving and borrowing
- Real rate = nominal rate − inflation (Fisher equation)
Crowding out
Government deficits shift demand right → higher interest rate → less private investment. Size depends on conditions: large near full employment, small in recession (when saving is abundant and investment is weak).
Financial intermediation
- Banks — take deposits, make loans, bear credit risk, earn the spread
- Bonds — loans from buyer to issuer; interest payments; vary by risk and maturity
- Stocks — ownership shares; dividends + capital gains; riskier than bonds, higher expected return
Risk premium: higher risk → higher expected return. Diversification: spreading investments reduces risk without reducing expected return. Index funds exploit this.
Efficient market hypothesis
Prices reflect all available information. Weak and semi-strong forms have strong empirical support. Most active managers underperform index funds. EMH breaks down during bubbles and for some behavioral anomalies.
Personal finance takeaway: save early, diversify, keep fees low, don't panic, buy index funds.
Themes
- Behavioral — loss aversion in investing; bubble psychology
- Affects daily life — your savings, mortgage, 401(k), retirement