3 - Financial Markets and Financial Institutions

Abstract

This chapter discusses the economic functions of financial markets and financial institutions. These markets consist of a cluster of institutions that have as their principle function the transmission of funds from savers and lenders to business, consumer, and government borrowers. The cluster includes the stock and bond markets; financial intermediaries such as banks and thrift institutions, a number of highly specialized firms such as stock brokers and bond dealers, investment bankers, pension funds, investment companies, and insurance companies, and governmental agencies such as the Federal Reserve System, the U.S. Treasury, and federal lending agencies. The main job of financial markets is the transmission of loanable funds and financial capital from surplus income units to deficit spenders. Surplus income units are individuals and organizations whose current inflows of money income exceed their current money outlays. Deficit spenders are units whose current outlays exceed their current inflows of money. Thus, the existence of surplus and deficit spending units sets the stage for the development of financial markets. Although the main job of all these markets is to transmit funds between surplus and deficit units, their evolution has been characterized by a high degree of differentiation. Not all lenders want the same kinds of financial assets, and not all borrowers are willing to make the same kinds of commitments.