Global financial system

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The global financial system (GFS) is the financial system consisting of institutions and
regulators that act on the international level, as opposed to those that act on a national or
regional level. The main players are the global institutions, such as International
Monetary Fund and Bank for International Settlements, national agencies and
government departments, e.g., central banks and finance ministries, private institutions
acting on the global scale, e.g., banks and hedge funds, and regional institutions, e.g., the
Eurozone.

Deficiencies and reform of the GFS have been hotly discussed in recent years.

Contents
[hide]

• 1 History
• 2 Institutions
o 2.1 International institutions
o 2.2 Government institutions
o 2.3 Private participants
o 2.4 Regional institutions
• 3 Perspectives
• 4 See also

• 5 Criticism, discussions and reform

[edit] History
The history of financial institutions must be differentiated from economic history and
history of money. In Europe, it may have started with the first commodity exchange, the
Bruges Bourse in 1309 and the first financiers and banks in the 15th–17th centuries in
central and western Europe. The first global financiers the Fuggers (1487) in Germany;
the first stock company in England (Russia Company 1553); the first foreign exchange
market (The Royal Exchange 1566, England); the first stock exchange (the Amsterdam
Stock Exchange 1602).

Milestones in the history of financial institutions are the Gold Standard (1871–1932), the
founding of International Monetary Fund (IMF), World Bank at Bretton Woods, and the
abolishment of fixed exchange rates in 1973.

[edit] Institutions
[edit] International institutions

The most prominent international institutions are the IMF, the World Bank and the WTO:

• The International Monetary Fund keeps account of international balance of

payments accounts of member states. The IMF acts as a lender of last resort for
members in financial distress, e.g., currency crisis, problems meeting balance of
payment when in deficit and debt default. Membership is based on quotas, or the
amount of money a country provides to the fund relative to the size of its role in
the international trading system.
• The World Bank aims to provide funding, take up credit risk or offer favourable
terms to development projects mostly in developing countries that couldn't be
obtained by the private sector. The other multilateral development banks and
other international financial institutions also play specific regional or functional
roles.
• The World Trade Organization settles trade disputes and negotiates international
trade agreements in its rounds of talks (currently the Doha Round).

Also important is the Bank for International Settlements, the intergovernmental

organisation for central banks worldwide. It has two subsidiary bodies that are important
actors in the global financial system in their own right - the Basel Committee on Banking
Supervision, and the Financial Stability Board.

In the private sector, an important organisation is the Institute of International Finance,

which includes most of the world's largest commercial banks and investment banks.

[edit] Government institutions

Governments act in various ways as actors in the GFS , primarily through their finance
ministries: they pass the laws and regulations for financial markets, and set the tax burden
for private players, e.g., banks, funds and exchanges. They also participate actively
through discretionary spending. They are closely tied (though in most countries
independent of) to central banks that issue government debt, set interest rates and deposit
requirements, and intervene in the foreign exchange market.

[edit] Private participants

Players active in the stock-, bond-, foreign exchange-, derivatives- and commodities-
markets, and investment banking, including:

• Commercial banks
• Hedge funds and Private Equity
• Pension funds
• Insurance companies
• Mutual funds
• Sovereign wealth funds

[edit] Regional institutions

Examples are:

• Commonwealth of Independent States (CIS)

• Eurozone
• Mercosur
• North American Free Trade Agreement (NAFTA)

[edit] Perspectives
There are three primary approaches to viewing and understanding the global financial
system.

The liberal view holds that the exchange of currencies should be determined not by state
institutions but instead individual players at a market level. This view has been labelled
as the Washington Consensus. This view is challenged by a social democratic front which
advocates the tempering of market mechanisms, and instituting economic safeguards in
an attempt to ensure financial stability and redistribution. Examples include slowing
down the rate of financial transactions, or enforcing regulations on the behaviour of
private firms. Outside of this contention of authority and the individual, neoMarxists are
highly critical of the modern financial system in that it promotes inequality between state
players, particularly holding the view that the political North abuse the financial system
to exercise control of developing countries' economies.

[edit] See also

• Financial transaction tax
• Finance
• Financial crisis of 2007-2010
• Financial economics
• Financial regulation
• G20
• Global governance
• Globalization
 • International monetary systems
• List of finance topics
• List of international trade topics
• Trade bloc

[edit] Criticism, discussions and reform

Among the many critics of the GFS are:

• The ATTAC network

• Bretton Woods Project
• George Soros
• Joseph Stiglitz
• Paul Krugman
• Ann Pettifor
• Michel Barnier
• Pope Benedict XVI has urged a major overhaul of the global financial system.

[hide]
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General areas of finance

Financial markets · Investment management · Financial institutions · Personal finance ·

Public finance · Mathematical finance · Quantitative behavioral finance · Financial
economics · Experimental finance · Computational finance · Statistical finance
Retrieved from "http://en.wikipedia.org/wiki/Global_financial_system"
Categories: International trade | International economics | Economic systems | World
economy | International finance
Hidden categories: Articles lacking sources from October 2010 | All articles lacking
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WEST HILLS COLLEGE

ECONOMICS

26
Saving, Investment, and the Financial System

THE MARKET FOR LOANABLE FUNDS

• Financial markets coordinate the economy’s saving and investment in the market for
loanable funds.
• Just a note: When we are talking about interest rates in this chapter we are talking in
real terms.
• Also remember that we are talking about macro economics and the LONG RUN.
THE MARKET FOR LOANABLE FUNDS
• The DEFINITION: market for loanable funds is the market in which those who want to
save supply funds and those who want to borrow to invest demand funds.
THE MARKET FOR LOANABLE FUNDS
• Loanable funds refers to all income that people have chosen to save and lend out, rather
than use for their own consumption.

Supply and Demand for Loanable Funds

• The supply of loanable funds comes from people who have extra income they want to
save and lend out.
• The demand for loanable funds comes from households and firms that wish to borrow to
make investments.
Supply and Demand for Loanable Funds
• The interest rate is the price of the loan.
• It represents the amount that borrowers pay for loans and the amount that lenders
receive on their saving.
• The interest rate in the market for loanable funds is the real interest rate.
Supply and Demand for Loanable Funds
• Financial markets work much like other markets in the economy.
• The equilibrium of the supply and demand for loanable funds determines the real
interest rate.
Add Figure 1 The Market for Loanable Funds

Supply and Demand for Loanable Funds

• Government Policies That Affect Saving and Investment

• Taxes and saving

• Taxes and investment
• Government budget deficits
Policy 1: Saving Incentives
• Taxes on interest income substantially reduce the future payoff from current saving and,
as a result, probably reduce the incentive to save.
Policy 1: Saving Incentives
• A tax decrease increases the incentive for households to save at any given interest rate.
• The supply of loanable funds curve shifts to the right.
• The equilibrium interest rate decreases.
• The quantity demanded for loanable funds increases.
Add Figure 2 An Increase in the Supply of Loanable Funds

• If a change in tax law encourages greater saving, the result will be lower interest rates
and greater investment.

Policy 2: Investment Incentives

• An investment tax credit increases the incentive to borrow.
• Increases the demand for loanable funds.
• Shifts the demand curve to the right.
• Results in a higher interest rate and a greater quantity saved.
• If a change in tax laws encourages greater investment, the result will be higher interest
rates and greater saving.
Add Figure 3 An Increase in the Demand for Loanable Funds

Policy 3: Government Budget Deficits and Surpluses

• When the government spends more than it receives in tax revenues, the short fall is
called the budget deficit.
• The accumulation of past budget deficits is called the government debt.

• Government borrowing to finance its budget deficit reduces the supply of loanable
funds available to finance investment by households and firms.
• DEFINITION: This fall in investment is referred to as crowding out.
• The deficit borrowing crowds out private borrowers who are trying to finance
investments.
Policy 3: Government Budget Deficits and Surpluses
• In the long run, a budget deficit decreases the supply of loanable funds.
• Shifts the supply curve to the left.
• Increases the equilibrium interest rate.
• Reduces the equilibrium quantity of loanable funds.
Figure 4: The Effect of a Government Budget Deficit

• When government reduces national saving by running a deficit, the interest rate rises
and investment falls.
• A budget surplus increases the supply of loanable funds, reduces the interest rate, and
stimulates investment.

The Financial System

• The financial system consists of the group of institutions in the economy that help to
match one person’s saving with another person’s investment.
• It moves the economy’s scarce resources from savers to borrowers.
• DEFINITION: The financial system is made up of financial institutions that match one
person’s savings with another person’s investment.
• Financial institutions can be grouped into two different categories:
• financial markets
• financial intermediaries.
FINANCIAL INSTITUTIONS IN THE U.S. ECONOMY
• Financial Markets
• Stock Market
• Bond Market
• Financial Intermediaries
• Banks
• Mutual Funds
• Insurance Companies
• etc
FINANCIAL MARKETS
• DEFINITION: Financial markets are the institutions through which savers can directly
provide funds to borrowers.
• DEFINITION: Financial intermediaries are financial institutions through which savers
can indirectly provide funds to borrowers.

Financial Markets:

BONDS

• The Bond Market

• DEFINITION: A bond is a certificate of indebtedness that

specifies obligations of the borrower to the holder of the bond.
• Bonds pay interest to compensate the person who loaned the money to the bond issuer.
• Companies and governments issue bonds:
• The US Government issues US Treasury Bonds which are among the safest bonds in the
world.
• Corporations and even little cities issue bonds.
• The higher the risk, the more interest bonds usually pay.
Types of Bonds
• Bonds can be very safe investments
• US Treasury Bonds
• They pay a lower rate of interest
• Very high grade corporate bonds- like General Electric
• Or bonds can be risky
• High Yield also called Junk Bonds
• They pay a high interest rate!
• Some Other Characteristics of Bonds

• Term: The length of time until the bond matures.

• The date when you get your money back.
 • Long term bonds are riskier and so pay higher rates of interest.
• Credit Risk: The probability that the borrower will fail to pay some of the interest or
principal.
• Be careful of this if you buy bonds!
• US Bonds are the lowest credit risk domestic bond and pay the lowest interest.
• Tax Treatment: The way in which the tax laws treat the interest on the bond.
• The interest on most bonds is taxable.

STOCKS

• DEFINITION: Stocks represents a claim to partial ownership in a firm and is therefore,

a claim to the profits that the firm makes.
• When you buy a stock, you are actually becoming one of the owners of the company.
• The sale of stock to raise money is called equity financing.
• Compared to bonds, stocks offer both higher risk and potentially higher returns.
• If the company in which you buy the stock does very well, the value of your stock will
go up.
• Whereas if you own a bond in the same company , its value won’t change or at least it
won’t change very much.

•• Profits: Companies can do two things with the profits

• They can pay Dividends which are the share of profits that companies pay to the stock
holders.
Dividends DEFINITION: Dividends are the profits paid to stockholders
Some companies have been very relaible about paying dividends
Recent favorable treatment of dividends

• Or they re-invest the profits into the company to make it grow.

• You as a shareholder benefit from profits either way
• So as a share holder you are very interested in profits or earnings as they are also called.

FINANCIAL INTERMEDIARIES

• Financial intermediaries are financial institutions through which savers can indirectly
provide funds to borrowers.

Types of Financial Intermediaries

• Banks
• take deposits from people who want to save and use the deposits to make loans to
people who want to borrow.
• pay depositors interest on their deposits and charge borrowers higher interest on their
loans.
•
Other Financial Intermediaries
• Mutual Funds
• A mutual fund is an institution that sells shares to the public and uses the proceeds to
buy a portfolio, of various types of stocks or bonds, or both.
• Mutual funds allow ordinary people to easily buy a diversified group of stocks or bonds.

• With a mutual fund you hold a whole basket of bonds and shares of different
companies.

• Other Financial Institutions

• Credit unions
• Pension funds
• Insurance companies
• Loan sharks
SAVING AND INVESTMENT IN THE NATIONAL INCOME ACCOUNTS
• Lets look at the economy from an accounting point of view.
• Recall that GDP is both total income in an economy and total expenditure on the
economy’s output of goods and services:
DEFINITION: If T > G, the government runs a budget surplus because it receives more
money than it spends.
The surplus of T - G represents public saving.
• DEFINITION: If G > T, the government runs a budget deficit because it spends more
money than it receives in tax revenue.