flow-of-funds analysis and the economic outlook
TRANSCRIPT
This PDF is a selection from an out-of-print volume from the National Bureau of Economic Research
Volume Title: Annals of Economic and Social Measurement, Volume 6, number 1
Volume Author/Editor: NBER
Volume Publisher:
Volume URL: http://www.nber.org/books/aesm77-1
Publication Date: 1977
Chapter Title: Flow-of-Funds Analysis and the Economic Outlook
Chapter Author: George M. von Furstenberg
Chapter URL: http://www.nber.org/chapters/c10500
Chapter pages in book: (p. 1 - 25)
A,inal o/ / onomw a,,tl Social !tfeasure,,ieni, 6/i, /977
FLOW-OF-FUNDS ANALYSIS ANDTHE ECONOMIC OUTLOOK
B GEORGE NI. VON FuRsTiNnlRG*
roll! a natonaI inconu' acc000Li Jorc'ea.cI of the balance /'c'lIteCFl roo .(Ut!1i1 CJ#iIl flfl laircapital espi'iulitures and of ilti' 7000ev upp1i suppocec/ii copisi(te,li tlic'resi!/,. ihi.' paperlays oui File steps leading to a onip/ele los-of-Juiic/s tranlation of the forecast. i/us allotsa much broader set of financial relatioiishrps to be assessed i/la?? are usual/i co,is,derid inappraising i/it' oit!/ooA - i/it' parinular J/Out-OJ-Juiids ri'uonciliaiioa unc/eruilen ill f/ifS sicilyc1ur,n ihe .)J)rf!' o/ 1976 suggeis 1/1(11 (lie imp/it'd lu1iiuhi ratios Oft' so Iiii,'Ii as to cite lilt/csubs ((met' (it fears if fi,,a,ic iii! iris's or crolls/iflg-o:Jf ihrougli federal deft-its III 1976 tiiul /977
Before the 1975 tax cut was passed, an intense debate arose over thepossible crowding out of private borrowing and creciit-tInanced privateexpenditures by Federal budget deficits. At the time, the economic declinearid added discretionary fiscal stimulus were projected to raise the Federaldeficit on the national income accounts (N IA) basis to S7() billion in fiscalyear 1976. With this information grafted onto previous forecasts of grossinvestment and gross saving,' some analysts inferred that ex ante grossinvestment demand and the deficit greatly exceeded x attic gross savingwhich is the sum of business and personal saving and net foreign invest-ment in the United States. They concluded that private investment planscannot be reafized if the Federal government financing is as large as pro-jected.
Other researchers attempted to use flow of funds analysis to eitherprove or disprove that there would be a deficit financing problem. Sincenone of the large published econometric models had a fully developed andintegrated flow of funds sector at the time,2 consistent forecasts allow-ing interactions between expenditures, savings and sectoral financial flowswere as yet unavailable.3 As a result, different students of the deficit
* Resdent Economist, American Enterprise Institute, and Professor of Economics.lndiana University. I am greatly indebted to Stephen P. Taylor. Chief, Flow of FundsSection. Board of Governors of the Federal System for expert advice, hut he is in no wayresponsible for any errors of either fact or judgment that remain.
IFOr past quarters, the sources and uses of gross saving are published in the nationalincome accounts section of the Surey of(urn'ni Business, Table 15 (I able 5.1 in NationalIncome Accounts issues).
2The integration of national-income and flow-of-funds accounts into one completemodel has progressed in recent years. For discussions of various stages see Lass rencc R.Klein, "Econornetricsof Inflation. 1965 74," paper presented at the NBFR Conference onResearch in Income and Wealth, Nov. 1974: and Gary Frointn and Allen Sinai, "A PolicySimulation Modd of Deposit Flows, Mortgage Sector Activity, arid Hocusing," paper pre-sented at Econometric Society Meeting, San Francisco, Dec. 1974.
3A consistent internal forecast is prepared for the Federal Reserve Board of Governors.
financing problem reached very dil1irent conclusions.4 One analyst ex-pected the Fed to nloneli/e the hulk of a 70 billion Federal deficit andsuggested that the prime rate of commercial banks might be driven up to20 percent by the end of 1975 or in early 1976 as rates of inflation wouldthen he expected to surge. Others argued that "the lilterplay of Steepdeclines in economic activity and easing monetary policy a fords latitudefor an orderly matching of supply and demand for credit during l975,''
The evidence that has accumulated since the time hen these predic-tions were made has supported the latter view. While real business fIxedinvestment in the first quarter of 1976 had still not quite recovered to itsyear-earlier level, large reserves of excess capacity rather than crowdingout restrained investment, as long-tern bond rates were steady and shortrates declined throughout 1975. Ftirtheriiiore, both residential investmentand Inventory investment were much higher than in the first quarter of1975. Nevertheless the crowding out debate has not been stilled. Rather,many of those ho started the debate now argue that unless the Federaldeficit is reduced considerably more rapidly than it would he tinder aconstant full-eniploment surplus, crowding out will Occur in more ad-vanced stages of the present expansion, perhaps as earl as l977.Others, however, dispute the vies that crowding out is imminent or thatfiscal policy stimuli would be at the expense of' private investment in thenear futurc.K
}:tced with such divergent judgments, there is a need for factual in-quiries to narrow the range of disagreement. Unhortunatelv such inquiriesare hampered by flow -of-funds analysis and its integration with nationalincome accounts analysis being inaccessible to most general economistswho would like to form a judgment of their own. As a partial remedy, thispaper attempts to explain how economists who are equipped with littlemore than the usual forecasts of the income and product account com-ponents of GNP and with the growth rates of the money supply sup-posedly consistent therewith can engage in some rudimentary analysis tocheck whether the financing implications of the forecast are at all con-sistent with the forecast of NIA expenditures.
4Scc Walter E. Hclkr, "i)clicii: Where is Thy Sting?" Wall Street Journal. March 7,1975.
5Sec the revies article, "Crowding O'it:' Wall Street Journal, March 3, 1975, p. lb.'C,,ri ihe Government 1 inance 1 hose Big Delicits?". Morgan Guaranty Survey,February, 1975, p.4.
71or a discussion of the concept of cross ding out and applications to the present cx-pansion see Keith M. Carison and Roger w. Spencer, "('rowding Out atid Its Critics,''!e/,'ra( Reserve Ba,:!, of Si. l.ouzs Reis,'w, l)ecemher 1975, pp. 2 17; Economic Repuri / I/it'President, January 19Th, pp. 46 47; and Keith M. Carlson, "The 1976 Economic Reportand the Federal Budget: 1 owards a E.ong-ruii lcrspcciivc," h'deral Reserve Bank of Sil.ou,v Rerii',c. April 1976, pp. 2 Ii.
5Congressional Budget Oltice, Budget Op:ionv for Fiscal Fear /5)77. A Report to thesoul house ( s'nun,f(ees on the /h,/i',i ..\l ;trch . I L)7( Pp -
T1
I 'T
GRoss SAVING nv Sicroks
The first step in the process of deriving a flow-of-funds reconciliationis to translate the N IA table of gross saving, which is routinely suppliedin econometric forecasts, into the corresponding flow ol Funds tableswhich are generally not provided. As Table I shows, For all sectors coni-bined this involves merely the addition of (he government NIA budgetbalances and of expenditures on consumer durables to gross private NIAsaving.
Like producers' durables, consumer durables are debt-financed to a
significant extent. In the flow of funds accounts, consumer durables arethus added both to the gross saving and to the gross investment of' thehousehold sector. Apart from this addition, gross investment is detined inthe same way as in the NIi accounts even though its distribution by sec-tors, and the distribution of the corresponding capital consumption al-lowances, is more detailed than in published Nli\ breakdowns as shosnin Tables 2 and 3.
Before gross saving by households can be derived on the basis pub-
TABLE IRElATION BETWEEN NIA Fm.ow or Fusos MEASURES
or GROSS SAVING, Aim. SEctoRs, 1973 77(S BIlLION)
Note: Deta!l may not add to totals because of rounding.aForecasts of NIA components are taken from the DRI control solution dated April 26.
1976 with the exception of noncorporate capital consumption allowances which are assumedto grow by 10 percent per annum From 1975 to 1977, assuming a 6 percent rise in replace-nient costs.
bSince the capital consumption adjustment is included, replacement-cost depreciationrather than historical-cost depreciation is show-ri here. For an CXl)laflation of the capitalconsumption adjustment (CCA) see All-an I-I. Young, "New Estimates of Capital Consump-tion Allowances in the Benchmark Revision of GNP," Suriet' of Current 8usincs. vol. 55(October 1975), pp. 14 16, 35.
3
1973 1974 1975 I976' l97,
Personal Saving 72.7 74.0 88.9 88.8 101.3Undistributed Corporate Profits 40.9 48.4 38.4 59.5 69.2Corporate Inventory Valuation Adjustment -18.4 - 38.5 --10.8 -13.0 - l7.7Capital Consumption Adjustment 1.6 -2.3 -5.7 - 7.5 -9.3Corporate Capital Consumption Allowancet' 71.9 82.1 93.5 104.4 116.5Noncorporate Capital Consumption Allowances 45.2 52.0 58.5 65.0 71.4
Total: Gross Private Saving. NIA Basis 213.8 215.7 262.8 297.2 331.4
Gross Private Saving. NIA 213.8 215.7 262.8 297.2 331.4Federal Government Surplus or Deficit ( -) -6.9 -11.1 -74.6 -62.8 -42.5State and Local Surplus or Deficit (-) 12.9 8.1 9.8 16.8 15.8Consumer Durables 122.9 121.9 128.1 155.8 178.5
Total: Gross Saving. Flow of Funds Basis 342.7 334.0 326.1 407.0 483.2
TABlE 2Rn.k1 ION BFTWIF5 NIA A'Is F OW 01- I'L3i)S Mi ASHRI-S
Note: 1)etail may riot add to totals because of rour.ding"Includes between SI and 52 billion of rcsidenti;il iflvesfnitnt in producers' durableequimentThe estinlates for 1976 and 1977 were prepared independently with some regard to theassumed pal tern of undistrihuted profits of hank and nonhank linancj;il corporations (5ev'Table 5).This item consisi5 maifl( of n1ult-fainily construct jo,1 which is assumed to make .,sloss recoscry.
lished in the how of funds, three other items Iflust be added, hut theseadjustments arc not of significance to credit market analysis, and they caneasily be omitted if convenient Table 4 indicates that one of these, thecapital gains dividends of open-end Investment companies, is numericallyInsignilicant The other two items derive i'roiii the growth of certaingovernillent retirement funds which are construed to be funded actuarially9This item is treated as a reduction of the retained earnings uI nonhank financial insti-tutions so that its addlti,)n to houcehold sector saving has no effect on total gross sas inp inTable I.
4
(IF TOTAl PKIVAIt. ('API I Al l'Xi'LNI)Jl (R1'S, 973 77(S uu lioN)
(973 1974 1975 1976 1977
Nonresidcntjil Structures 49 0 544 52 7 57.4 64 IProducers' I)urable Equipment 675 93 5 95.8 1070 125 4Total Nonresidential136.5 147.9 48.5 164.4 189.5
total Residential Slructures 66.5 54 6 487 660 83 2Total Change in Business Inventories
17 5 9 7 14.6 17 5 23 8
Gross Private E)omes(jc Investment NIA 22(3 5 212 2 (82 6 247.9 296 5
Plant and Equipment Nonprofit fnstitutioiisb 6.3 6.3 5 7 6 0 6.0Plant and Equipment Nonfinancial Businesses 125.2 135 2 133 3 150.4 175 8Plant and Equipment Commercial Ranksh 30 3 8 46 40 4.2Plant and Equipment l'rivate Nonliank Finance0 20 2 6 49 4 3.5Total I'Iant and Equipment136.5 47.9 148.5 64.4 189.5
Residential ('onstruclion Househokls 44 5 37 7 35 3 48 6 60 0Residcntiil ('onsiruction Nonhjnicjil Busiiis 21 7 16.5 2.6 17.0 23 0Residential Constructiop Private Nonhank
0.2 0.4 0.9 0.4 02Iotaj Residential Construction66 5 54.6 48.7 66.0 83.2
Inventory Change7.5 9.7 --- (4.6 17.5 238
Subtotal220.5 212.2 82.6 247.9 296.5
Plus: Consumer Durabjes122.9 121.9 128.1 558 118.5I otal: Private Capital Expenditures
Flow of Funds Basis3434 334.1 3(0.7 403.7 4750
Note: Detail nia not add to totals because of rounding.5L)etails by type of business are given below:
TAHI.F 3
RIt,ATI0N BnwtiN NIA ANO Flow IIJN1)S MEASL:RI.SOF ('AF'lTAi. (oNsutpuoN At i.OW.xNUFS, 1973 77
( liii liON)
bDeprecialion on the assets of households (including nonprolit institutions) andfinancial businesses involves mainly structures. It is assumed to gross by 10 percent perannum during the forecast period.
CGiven the NIA totals and the estimates explained in the preceding note, business de-predation is obtained as a residual.
dt:orecast estnmates for the years 1976 and 1977 are derived by using the formulaD = 0.84(1 + i)D_ + 0.161, sshere D. I and i arc replacenient-cost depreciation, grossinvestment, and the year-to-year change in the implicit dcflator, all for consumer durahlcs.respectively. For 1975, depreciation estimated by this formula souId ditler from the actualdepreciation by less than SI billion.
at least for State and local governments.'0 Because the "reserves" ofFederal retirement funds are enirely "invested" in Treasury accounts orinterestbearing government debl. the Federal insurance adjustment will
iOState and !ocal retirement funds are construed as insurance by the nonhank linamiceSector with the growth in inSurance reserve liabilities financed by 'loans" from householdsinstead of the taxes actually paid. Hence household savings are raised by the same amountby which the NIA budget balance of State and local government is reduced. In the flow offunds accounts, the growth in the reserve liabilities of the Federal retirement funds remainsin the U.S. Government sector.
5
1973 1974 1975 t976 1977
Corporate Cauital Consumption Allowances 71.9 82.1 93.5 104.4 116.5Noncorporate Capital Consumption Allowances 452 52(1 58.5 65.0 7 4
Total: Depreciation, MA Basis Ill.! 134.0 152.0 69.4 187.9
Depreciation on Household Assets Other ThanConsumer Durablesb 20.2 23.0 25.9 28.5 31 3
Depreciation by Private Domestic NonlinancialI3usincssc 937a
107.3 121.7 1.36.1 151.3Depreciation on Commercial Bank c5.t5b 1.8 2.2 2.5 2.7 3.0Depreciation on Assets of Private Nonhank
Financial Institutions5 1.4 .6 l.) 2.! 2.3
Subtotal: 117.1 134.0 152.0 169.4 187.9['lus: 1)eprcciation on Consumer
Durablesd 98.6 110.8 121.7 32,2 144.2
Total: I)epreciatioii, Flow of Funds Basis 215.6 244.8 273.7 301.6 332 I
Farm Corporate 0.6Farm Noncorporate 7.8Corporate Nonfarm 68.1Noncorporatc Nonfarm 17.2
Total: 93.7
S
TABLI: 3
Rit;iiii\ 131 i'. ii NI/S Al Ii (YV 01 It\IO ;(
Note: Detail ma- not add to totals because ot ro u ndiiig3Th eslinlates for 0116 and 1977 hase been nitorined h the fiscal scar changes in trustfund balances shoun n the U.S. Rio/en',. Special Analysis B.bExtrapl,mIt,ofl based on the assumption that stock prices renialn, on a slight uptrcndthrough 1977.
be omitted in setting up household flows.'' Hoxever, the net inflows toState and local governnicnt retirement systems are recognized as a sourceof funds to credit markets flowing through the insurance sector and aretaken out of State and local government surpluses as they appear in NIA.
The gross saving by private domestic nonfinancial business, on a flowof funds basis, is most difficult to derive from the estimate of undistributedcorporate prolils including the inventory valuation adjustment (IVA) andthe capital consumption adjustment (CCA) provided in the NIA accounts.Undistributed profits of commercial bank and private nonhank financialcorporations must be subtracted and depreciation by private domesticnonfinancial business must he added. The net saving of unincorporatedbusinesses is assumed to be zero or very close to zero in the flow of fundsaccounts since the net income of such businesses is generally assumed toflow through the household sector. Hence the gross saving by private do-
'This treatnient is not intendcd to deiiy that Federal eniplo\ee arid railroad retireniefltS'sterns can add to the expected retiremncr,t si calth iii the participants hut then so does sialsecurity even though financedon a pay-asyou.go basis. Hence aadit ions to reserses do notprovide a Correct measure of the Increase in the present value of Federal retirement andold-age benefits. See Marti,i S. Feldsteun
"Social Security, Induced Retirement, and Ag-gregate Capital lorniatron"JQur,,Q/ 0/ J'o/jfjnU/ '0Fii$7;- Septeni her/October 1974. pp905-2,.
6
ol l'i iscossi sNI) lIotsiiioi t) Ss\1N,,(S liltilliN)
971 77
973 1974 97S 1976 977
Persoiial SavIng. N I/S IasisSurplus of Federal (iovern men t I mplos ees amid
72.7 74.0 88 () 88.8 101 3
Railroad Retirement Funds a 2.7 5.3 5.2 47Surplus of State and Local Employees Retirement
I-u imds
Capital (,ams Divideinds ol Investment Corn b
Consumer DurahksE)epreeiation on household Assets Other 1 han
0.9122.')
'180.5
121.9
Ill0.2
128.1
10.5
1(3
t55.
05I 0
78.5
Consumer Durables 20.2 23.0 25.9 285 31.3
Total: (i russ Sa sing h I-lousehold. PersonalTrusts, and Nonprotit Organi,at ions. Floss oFunds Basis
1 otat excluding Surpluses of Federal)$ 234.5 259.4 29 3 326 V
(ioscrm,Jflcnt Retirement F unds 225.5 229 2 2542 2846 322 o
TABLE 5MA ANt) Fi.ow ov Fusos Co%IPOY*sIs OF (15055 SAVINGor PRIVATI Dosiisrtc NOM IN.AN(1AI. BLS!Nl 551:5, 973 77
$0.3 billion of net sasings by tarot corporations are included in this figure.bThe estimates for 976 and 1977 are based on the assumption of above-norma! realii.a-
tion of loan losses b commercial banks in 976, follossed by higher short.tcrrn interest rateswhich benefit hank earnings in 1977 but reduce the earnings of nonhink tinancial Institu-tions.
eSince the capital gains dividends of open-end Investment companies, both cash andretained, arc not included in personal income in thc NIA accounts, but arc included inhousehold income in the tlow-of-funds accounts, they are subtracted from the NIA reten-tions of open-end investment companies. With these retentions thus reduced, the capita!gains dividends must be subtracted separately so as to eliminate the entire amount of Nl\retentions of nonbank financial institutions.
mestic nonfInancial business (including foreign branch profits) is aboutequal to the net cash flow of nonfinancial corporations (including IVAand CCA) plus noncorporate replacement-cost depredation. Undistrib-uted corporate profits of the financial sector var' with changes in interestrates, in capital gains, and in Federal regulations, hut no major errors'2are likely to be introduced if only small changes are assumed for futureyears as shown in Table 5. The insignificant amounts of income retainedby Federally sponsored credit agencies and not paid to the Treasury by theFederal Reserve also vary little,
Given the type of information provided in the lirsi note to Table 3, itwould be quite simple to decompose gross business saving into its farm.noncorporate nonl'arm, and corporate nonfarm components. Ignoring
t2Errors in excess of SI billion are considered unlikely.
7
lilt I
1973 1974 1975 976 1977
Undistributed Corporate Prolits with IVAand CCA, NIA Basis 24. I 7.6 21.9 39.0 42.2
Minus: Capital Gains Dividends of Investment(ompaIIicSc 0.9 0.5 0.2 IA) 1.0
Undislributed Profits of CommercialBanking Corporations5 4.5 4.9 4.6 17 4.5
Undistributed Protits of Private Non-hank Finance (orporationsL 5.3 4.7 5.3 5.5 5.3
Income Retained by Federally SponsoredCredit Agencies and MonetaryAuthorities 0.5 0.7 0.6 0.7 0.7
Plus: Depreciation by Private 1)oniesticNontinancial Business 93.7 107.3 121.7 136.1 151.3
Total: Gross Saving by Private DomcsticNonfinancial Busincss. Flow of FundsBasis 106.6 It-I. I 132.9 164.2 182.0
the small amount of positive or negative earnings retuiiied ill Farm coporatiollS in recent years, gross saving by 1)0th the farm and flOflcorporanonfarni sectors would he equal to the capital coflstiiliption alk alice,arising in these sectors. 1-lowever, to keep the presentation inanageihithe nonfinancial domestic buSineSs sector will remain COflSOftd:ited in subsequent tabks.
The only other item that remains to he considered is the rest of theworld sector. Gross saving for the loreign sector is the negative equivaIei1of net foreign investment as defined in N IA since net foreign investnienfby the United States represents a use (or negative source) 01 savings. In theabsence of errors and omissions, the net change in lending to l'oreignerswould, of course, have to match net foreign investment which is con-ceptualR equal to the balance on cUrrent account with siii rcverse(1 iii thetable of saving with only minor niodilications.° Provided I1ilj5 errorsand omissions do not lriSe in the current account hut mainly from in-complete reporting of private international capital tlt)% s, errors and on-
sions max' be set to tero to identiIv the net change in lending to foreignersfrom the current account balance.
As accounting identities, gross saving and gross ifl' estillent mustbalance. In Tables I and 2, the di flrence between total gross saving andgross domestic investment (N IA) or private capital expenditures (flow offunds) is due to net foreign investment (subtract - 50.3 (billion) in 1973,-.$2.8 in 1974, and SI 2.8 in 1975 from gross saving), net capital grants
received by the United States (add - $2.0 in 1974) and the statistical dis-crepancy (add $0.4 in 1973, 50.6 in 1974, and $2.6 in 1975). In the DRIincome and product forecast which is used in this paper, statistical dis-crepancies are zero, and no further net capital grants are assumed to bemade by the U.S. government. Hence, for 1976 and 1977. net foreign in-vestment (with sign reversed) is equal to the difference between privatecapital expenditures shown on the last line of Table 2 and the total grosssaving shown in Table I -
NET FINANCIAL IN\'ESEMINF
The next step in the transition from the NI!\ to the flow-of-fundsorganization of accounts is to derive net financial investment by sectorsfrom the exogenous stipulations and forecasts of NI A components alreadyexplained in the previous tables. In this forecast, the DRI control solutionof April 26, 1976 is used which represents the first model solution afterrelease of the preliminary data for the first quarter of 1976. The infornia-tion supplied in Tables I through 5 is sufficient to obtain every componentshown in the top half of Tables 6 and 7 for 1976 and 1977, respectivek.
'3See Ij5, Department of Commerce Sun'1' 0/ ('tirrt',,( Bus:m' March t976. P 3noie 3
8
I
Since statistical discrepancies are assumed to be zero, the ditierence be-tween gross saving and private domestic capital expenditures shown foreach sector represents the net financial investment of that sector. Depend-ing on whether this amount is positive or negative, it is then added to orsubtracted from private domestic capital expenditures of that sector toobtain gross investment, both financial and real, in the flow-of-fundstense.
While the net financial investment derived from the flow of funds ar-rangenient of the N IA accounts for any sector must be equal to the netacquisition of financial assets less net issuance of debt by that sector, thisaggregated information is not enough for credit market analysis. Net assetflows must be distinguished from net borrowings within the overall con-strairt of net financial investment. Both assets and debt flows dependcrucially on the degree of monetary expansion and financial intermedia-tion. If the gross flows are unduly small relative to the net flows, it is un-likely that the forecast of NIA components can he realized unless greaterfinancial stringency has been fully anticipated in arriving at these fore-casts. For this reason, the money supply forecasts supposedly consistentwith the forecast of national income and product components are crucialto the consistency check based on an analysis of the implied flow of funds.
NET INVESTMENT IN CREDIT MARKET INSTRUMENTS
Given the DRI forecast of the increase in currency, demand deposits,M1, M2, large CD's, M3, and member bank reserves during 1976 andl977,' the growth in the demand and time liabilities of commercialbanks and of the savings institutions contained in the nonbank financesector are predetermined. The growth in life insurance and pension fundreserves is sufficiently smooth to allow exogenous projection althoughsome allowance is made for faster growth in private pension funds duringthe projected business expansion, growth which may be speeded throughnew legislation. The sectoral distribution of these deposits and reserves asassets is simplified by the fact that businesses, governments, and nonhankfinancial institutions generally add only small amounts to their holdings ofdemand and time and savings deposits so that the lion's share of any in-crease in the liabilities of financial sectors goes to increase householdliquid assets. The only items that can both be sizable and unpredictableare the investment in demand and time deposits by the rest of the worldand changes in business demand for certificates of deposits (CD's).
The increase in the interbank liabilities of monetary authorities in-volves changes in member bank reserves and vault cash held by corn-
4To estimate stocks at yearerid from quarterly forecasts, the average of fourth quarterand first quarter figures is used at the turn of 1976 and 1977.
9
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1.7
49.0
49.0
627
62.'?
b2.7
7.6
7,6
7,6
33 0
33.0
33.0
1.5
1.5
IS
1.5
2.0
3.0
1.1
-.7.
5-6
5.2
-101
.90
4.3
-63
- 63
.90.
47.
867
.n10
5.1
0
6.3
1,0
1.0 .0
-3.3 2.
0
1.0
1.0
-62.
8 1.1
0.4
0.3
6.0
2.4
17.7
49.0
49.0
3.2 1.4
17.5
74.2
-20.
7
17.2
1.0
110.
2-0
.5
47.5
-0.5
62.7
0.0
7.6
33.0
168.
00.
5
-93.
8-2
1.2
4. G
ross
inve
stnl
ent
(5 *
lot
.SP
ri ta
le c
apt t
i Ias
pend
iture
sC
onyu
mer
dur
able
,R
esid
entia
l con
-iru
et o
nS
.P
lant
and
equ
ipm
ent
TA
BLE
7D
ER
IVA
TIO
N O
F N
ET
FIN
AN
CIA
L IN
VE
ST
ME
NT
AN
O IN
VE
ST
ME
NT
IN C
RE
DIT
MA
RK
ET
AN
D R
ELA
TE
D IN
ST
RU
ME
NT
S19
77(S
BIL
LIO
N)
Priv
atg
Dom
estic
Non
finan
cial
Sec
tors
6 ii
Fed
eral
IvS
tate
and
Rel
of
Spo
nsor
edP
rivat
eLo
cal
the
U.S
.C
redi
tM
onet
ary
Com
mer
cial
Non
hunk
All
Bus
ines
sG
over
nmen
tsW
orld
Gov
ernm
ent
Age
ncie
sA
utho
rity
Bun
ksF
inan
ceS
ecto
rs
175,
15
Frn
anei
al S
ecto
rs
4',1
1110
.
S
Tra
nsac
tion
Cat
egor
y
I.G
ri',s
s sa
ving
2.C
apita
l con
-su
m p
i ion
3.N
et S
avin
g (I
- 2
)
US 32
2.6
175.
5
47,1
US 1<
2.0
151.
3
30.7
US
U
5.3
5.3
S -S 2
-5.2
US
U
-42.
5
-42,
3
SU
0.4
0.4
SU
0.3
0.3
S
7.5
3.0
4.
US
7.5
2.3
5
US
4750
332.
)
42 9
322
6
244
5
171<
5
60 0
52.0
222
6
250
5.3
-5,2
-42,
50.
40,
37,
5
4.2
76 3.7
0.2
47.0
475.
0
175,
31<
12
Sec
tor
Hou
seho
lds
cred
it m
arke
t and
rela
ted
i at r
umen
Is(1
0 -
18)
-
9.In
vent
ory
chan
ge23
.823
.8
0. N
et IS
nanc
ial
inve
stm
ent(
I .-.
5)
78.1
-40.
65.
3-8
.2-4
2.5
0.4
0.3
3.3
3.9
0
ID
eman
d de
posi
ts a
ndcu
rren
cy18
.1I 5
1.0
1,0
0.8
4.5
I 8.5
Q.
23.0
23.0
12. T
ime
arid
sav
ings
aeco
U fl
Is
106.
370
2.0
4.0
62.8
56.5
I I'.3
119
.3
3,A
tcom
mer
cia)
bank
s51
.85.
02.
04.
062
.862
.862
8
4.A
r sa
ving
sin
stitu
tions
54.5
2.0
56.5
56.5
56.5
IS.
Life
insu
ranc
e re
serv
es8.
08.
08.
08.
06.
Pen
sion
fund
rese
rve,
.36
.836
.836
.836
.8
17. I
nter
bank
ilcm
s2.
92.
92.
92.
9
IS. N
et in
vest
men
t in
69.2
8.5
3.))
5.0
0.8
-7.4
-784
- 00
70
0 qu
id o
rin
sura
nce
clai
ms
II) +
2 +
151
0 7)
9. N
t inv
cstn
,eflt
in-9
1.1
-49.
12.
3-1
3.2
-43.
30,
47.
781
.704
.60
S
mercial banks netted against changes in Federal Reserve float and n loansto member banks. Changes in demand deposits due to the U.S. Govern-ment and to the rest of the world and in currency outside banks effectchanges in the monetary authorities sources of funds in the row for de-mand deposits and currency. Referring to Table 6, $22.6 billion growth inM1 forecasted for 1976 is thus composed of the net rise in demand de-posits at commercial banks ($17.7 billion) minus the increase in demanddeposits held by the U.S. Government at such banks (S I. I billion) andplus the rise in currency outside banks ($6.0 billion). The difference be-tween the growth of M4 (M2 plus large CD's) and of M1 yields the risein time and savings deposits at commercial banks, and the difference be-tween the growth of M3 and of M2 yields the rise in time and savingsdeposits at savings institutions. With the additional information that largeCD's outstanding at commercial banks are forecast to decline by $3.6billion in 1976 and to rise by $i26 billion in 1977, the growth of thevarious monetary aggregates can readily be extracted from the flow offunds translations in the bottom half of Tables 6 and 7.
Adding the growth in currency and demand, time and savings, andinsurance and pension fund assets or liabilities yields the net investment inliquid or insurance claims shown in row 18 of Tables 6 and 7. Subtractingthese amounts from the net financial investment of each sector yields thenet direct investment (lending less borrowing) in credit market and relatedinstruments by each sector as a residual.
Before such instruments are distributed as assets and debts by sectorsand before the adequacy of credit for the forecast of GNP components isanalyzed in the next section, the dramatic shift in financing is highlightedin Table 8 that has occurred since full employment was last approachedin 1973. Compared to 1973, households reduced their net borrowing in thecredit markets in 1974 by more than the increase in borrowing by business.The decline in the growth of home mortgage and consumer credit as wellas reduced acquisition of currency and demand deposits contributed tothe over $20 billion decrease in the net credit market borrowing by house-holds. This decline reflected falling sales of homes and consumer durables,particularly automobiles, in the course of 1974.
Consumer borrowing began to revive gradually in 1975 while netborrowing by nonfinancial business in the credit markets plummeted. Infact, business became a net lender in the credit markets as the sharp reduc-tion in business inventors' investment coupled with non-growing expendi-tures on plant and equipment on the one hand and the continuing rise incapital consumption allowances on the other lowered external financingrequirements. Though business borrowing is expected to increase in 1976and 1977, its net borrowing will still he well below the 1973 level. House-holds, however, will be borrowing about two-thirds more in 1976 and
14
TA
BLE
8N
ET
INV
ES
TM
EN
T IN
CR
ED
IT M
AR
KE
T A
ND
RE
LAT
ED
li'S
TR
LM5N
T. 1
973-
77(S
aiii
.io)
Fed
eral
lyS
tate
and
Res
tS
pons
ored
Priv
ate
Loca
lof
the
U.S
.bC
redi
tM
onet
ary
Com
mer
cial
Non
bank
Hou
seho
ldsb
Bus
ines
sG
over
nmen
tsW
orld
Gov
ernm
ent
Age
ncie
sA
utho
rliy
Ban
ksF
inan
ce
Not
e: S
ince
197
6 an
d 19
77 a
re e
stim
ated
with
out s
tatis
tical
dis
crep
anci
es, t
he s
tatis
tical
dis
crep
anci
esar
e ad
ded
to n
et fi
nanc
ial i
nves
tmen
t for
each
sec
tor
in 1
973
and
1974
to a
chie
ve c
ompa
rabi
lity.
Nct
inve
t.tm
ent i
n liq
uid
and
insu
ranc
e cl
aim
s is
then
subt
ract
ed to
obt
ain
net i
nves
tmen
t in
cred
it m
arke
t and
rel
ated
inst
rum
ents
for
each
sec
tor.
dDer
ived
from
Boa
rd o
f Gov
erno
rs o
f the
Fed
eral
Res
erve
Syt
e, F
low
of
Fun
ds 1
-76,
May
197
6. T
he r
emai
ning
dis
crep
anci
es r
or a
ll se
ctor
sco
mbi
ned
are
a --
$2.5
bill
ion
exce
ss o
f net
fina
ncia
l len
ding
ove
r bo
rrow
ing
in 1
973.
$0.
3 bi
llion
in 1
974,
and
-$2
.0bi
llion
in 1
975.
The
incr
ease
in th
e U
.S. g
over
nmen
t's li
fe in
sura
nce
and
retir
emen
t pro
gram
rese
rves
is n
ot tr
eate
d as
a u
se o
f fun
ds b
y th
e ho
useh
old
Sec
tor.
- "19
73u
l974
-55.
8-3
5.5
-56.
1-6
1.1
-3.4
-9.9
-5.1
-8.2
-7.1
-10.
10.
60.
99.
18.
258
.459
.055
.957
.019
75-4
8.9
4.6
-0.3
-13.
6-8
1.4
0.4
5.5
34.9
96.8
1976
-93.
8-2
1.2
4.3
-6.3
-63.
90.
47.
867
.610
5.1
1977
-91.
1-4
9.1
2.3
-13.
2-4
3.3
0.4
7.7
81.7
104.
6
S
1977 through credit market and related instruments than they did in 1973to finance purchases of homes and consumer durables.
Net issuance of credit market instruments by the Federal (ioverfl_went was about $70 billion higher in 1975 than in 1974 arid it will stillbe about $50 billion higher in 1976. From 1975 to 1977 the increase in netborrowing by business is expected to just match the decline in net borrow-ing by all levels of government combined. Financial investment in creditmarket instruments by the rest of the world will remain approximatelyunchanged. Hence faster growth in the liabilities of the financial sectors,particularly the commercial banks, than in 1975 is expected to satisfy theadditional credit market borrowing by households. It will be interesting tosee whether the projected changes in both the volume of intermediationand in the composition of assets held by various lenders are in fact likelyto be accomplished as projected. However, before the behavioral com-patibility of the various NIA and fInancial components can be appraisedwithin a complete system, the gross credit flows must be identified.
Tnt D;sTRwvTIoN oF NET INvIsT1INi INCREDJT MARKET INSTRUSIENTS
Having derived the net funds raised or advanced in the credit marketor through related instruments, the balance of the lending or borrowing ofeach sector is determined. In addition to these sector balance equations,there are equations requiring that borrowing and lending must match foreach instrument. If there are in sectors and ii instruments, satisfying insector equations and n-I instrument equations automatically implies thatthe equation for the nth instrument is also met. In this distribution ofcredit market lending and borrowing by sectors, U.S. Government securi-ties are treated as the residual instrument n. The net investment in thaiinstrument is used to establish balance in each of the in sectors after then-I other instrument equations have been specified.
Referring to the bottom panels of Tables 9 and 10, the first step inpeeling out the credit market is to stipulate transactions by means of those"related" instruments which are substitutes for transactions effected in thecredit market proper. Corporate shares, equity in noncorporate business,miscellaneous claims, and trade credit are the most important items in thisgroup. Since both miscellaneous assets and liabilities and trade credit andtrade debt tend to be advanced and issued by the same sector, particularlyin the case of business, the net funds raised or advanced by any sector arefar less than the gross funds.
While the gross funds projections are indispensable for a study ofchanges in sectoral balance sheets, the "related" instruments can be com-bined and netted within each sector if the focus is on the distribution of
16
TA
BLE
9T
uE D
tsrR
IBuT
toN
OF
BO
RR
OW
ING
AN
D L
EN
DIN
G T
HR
OU
GH
CR
ED
IT M
AR
KE
T A
ND
RE
LAT
ED
INS
TR
UM
EN
TS
. 197
6: IN
ITIA
L A
PP
Rci
IMA
TIO
N(S
Bill
ioN
)
See
Tab
le 6
. ros
si 9
. Ent
ries
ilso
equa
l ihe
sum
ol'
sour
ces
min
us u
ses
in Ii
ncs
21 a
nd 3
0 ss
ith
sign
rev
erse
d.
Sec
tor
Hou
seho
lds
Bus
ines
s
Sta
le a
ndLo
cal
Gov
ernm
ents
Res
t of
the
Wor
ldU
.S.
Gov
ernm
ent
Fed
eral
lyS
pons
ored
Cre
dit
Age
ncie
sM
onet
ary
Com
mer
cial
Aut
horit
yB
anks
Priv
ate
Non
bank
Fin
ance
All
Sec
tors
Tra
nsac
tion
Cat
egor
yU
SU
SU
SU
SU
SU
SU
SU
SU
SU
S
20. A
ccou
ntin
g of
fset
or
net i
nves
tmen
t in
crd
mar
ket a
ndre
latc
d in
s1ru
men
ts
--93
.8-2
1.2
4.3
--6.
3-6
3,9
0.4
7.8
67.6
lOS
I0
21, C
redi
t Mar
ket
inst
rum
ents
3.7
94.0
28.8
450
8.0
3.2
8.8
14.0
0.0
78.6
12.0
0.6
8.1
71.8
3.5
99,7
2025
0.9
250.
9
2.U
.S.g
over
nmen
tse
curit
ies
1.7
8.5
8.0
8.8
75.6
-1.0
0.6
8.1
26.3
18.5
89.2
59.2
23.
Sta
te a
nd lo
cal
oblig
atio
ns1.
04.
03.
21.
0-0
.8-2
.03.
23.
2
24.
Cor
pora
te a
ndfo
reig
n bo
nds
I 022
.04.
05.
020
.026
.026
,0
25H
ome
mor
igag
ss56
.02.
04.
09
012
.532
.258
.058
.0
26.
Oth
er m
ortg
ages
2.0
20.0
2.0
3 0
7.5
9.5
22.0
22.0
27C
onsu
mer
cre
dit
32.0
2.0
14.0
6.0
32.0
32.0
28B
ank
loan
s n.
e.c.
2.0
1.0
5.0
7.0
1.0
8.0
8.0
29.
Oth
er lo
ans
2.0
4.0
5.0
3.0
1.0
3.5
4.5
2.0
2.5
12.5
0. R
elat
ed n
slru
men
ts-1
.52.
039
.044
.00.
51.
011
.012
.14.
71.
02.
00.
38.
05.
77.
60.
280
.380
.3
31.
Cor
pora
te s
hare
s0
56.
54.
811
.56.
56.
5
32.
Sec
urity
cre
dit
1.5
0 I
.00.
6.6
.6
33.
Tax
es p
ayab
le3.
00.
53.
70
30.
70.
24.
24.
2
34.
Tra
de c
redi
t0.
529
.027
.51.
01.
52.
00
531
.031
.0
35.
Equ
itY in
non
-co
rpor
ate
busi
ness
-4.5
-4.5
-'4.5
-4.5
36M
isee
llane
ous
cIai
Tns
2.5
10.0
1.5
5010
.01.
111.
02.
07.
08.
05.
010
.0$1
.31
.5
Priv
ate
Dom
estic
Non
finan
cial
Sec
tors
Fin
anci
al S
ecto
rs
TA
BLE
iOT
HE
DIS
TR
IBU
TIO
NO
F B
OR
RO
WIN
G A
ND
LE
ND
ING
TH
RO
UG
H C
RE
DIT
MA
RK
ET
AN
D R
ELA
TE
D IN
ST
RU
ME
NT
S,
1977
; IN
ITIA
L A
PP
RO
XIM
AT
ION
($ B
ILLI
ON
)
"See
raf
fle 7
. ro
9. E
ntrie
s tis
u eq
ual t
hesu
m o
lsol
irees
min
us u
ses
in l,
ites
2) a
nd m
with
sin
e re
sers
ed
Sec
tor
Priv
ate
Dor
nest
tc N
onfin
anci
alS
ecto
rs
Res
tth
e
Wor
ldofu.
s.G
over
nmen
t
Fed
era
Spo
nsor
edC
redi
tA
genc
ies
Fin
anci
al S
ecto
rs
Mon
etar
y C
omm
erci
alA
utho
rity
Ban
ksA
llS
ecto
rs
HoU
seho
ld5
US
Bus
ines
s
US
Sta
te a
ndLo
cal
Gov
ernm
ents
Prv
a)e
Non
burk
Fin
ançc
Tru
nsac
cion
Cat
egor
y
20. A
ccou
ntin
g of
fset
tar
net i
nves
tmen
t in
-91.
-49
IU
S 2,3
US
-13
2
US
-43
3
US 04
US 7.
7
US
US
US
cred
it m
arkc
i ind
rela
ied
inst
runl
enis
"
8) 7
1046
0
21 22
Cre
dit M
arke
tlil
stru
men
ts5,
903
,031
.879
.47,
5 4.
87.
36.
011
.056
.26.
013
650
834
4.0
98 I
20 2
790
- 00
23.
US
gov
ernm
ent
secu
ritIe
sS
taie
and
loca
l
19 3.0
253
7.5
7.3
56.2
.03.
68.
038
695
2790
698
24oh
ligat
ion
3 5
48I
0-0
2-2
548
25
Cor
pora
te a
ndfo
reig
n bo
nds
1.0
24.0
3 0
8 4
7 6
27 0
48
2725 27 28 29 30
Hom
e m
ortg
afes
Oih
er m
ortg
ages
Con
sum
er C
redi
tR
ank
loan
s n
ccO
ther
loan
s
Rel
ated
inst
rum
ents
0.0
60 0
2.0
360
2.0
3.0
3.0
54,Q
2.0
24.0
23 4
6.0
55.5
6.0
7.0
4.0
2 0
40
9.0
3 0
3 0
18.0 8 0
15.0
30.4
40
3) 0
13 1
3
18,0 1.0
is 0
2 0
02 0
26 0
36 0
31 4
n 0
0
821)
26 0
360
31 4
31 32.
33.
34.
35.
36
Cor
poru
te s
hare
sS
ecur
ity c
rcdi
lT
ancs
ptyi
Tra
de c
redi
tE
quit
in n
on-
corp
orat
e hu
s!ne
ss
1.0
- 5
0
2 0
0.5
44,0
16.0 tO
41,0
0.6
.0
0.6
I 0
0.0
.3,1
)
I 5
14.5
30
.9 9
2,0
03 03
II 3
1 3
90 10
177
120
0 7
92 02
95
0.0
20 254S
5
-.5
0
95,5
16,0
2 0
25 455
-50
Mis
cella
neou
scl
aim
s4.
0.5
0,0
2.5
5.5
II S
2 (1
00 s
Q5.
09
(i4
credit market instruments alone. On a net basis, households invest only afew billion dollars annually in related instruments, while business raises aroughly similar amount which varies with the balance of net equity issuesover net trade credit extended and miscellaneous assets acquired. The restof the world generally is a net borrower, mainly through miscellaneousliabilities, while the increase in taxes payable by business makes the U.S.Government a net lender in related instruments. The private nonbankfinance sectors, primarily pension and insurance funds, have tended toabsorb most of the net stock issues of businesses. Even though stipulationof the net balance of the investments in related instruments by each sectorwould probably be sufficient to prepare for an investigation of the con-sistency of credit market financing with the income and product accountsand with the money supply forecasts of econometric models, the grossflows are tentatively laid out in Tables 9 and lO)
The next step is to prepare independent estimates of the investment incredit market instruments other than U.S. Government securities whichmay be consistent with the DRI forecast of NIA components such as con-sumer durables and residential construction.'6 Investment in U.S. govern-ment securities is then derived as the balancing residual in the creditmarket. If the sectoral allocation of this residual violates the port-folio preferences and financial investment practices of any sector in anobvious way, an alternative distribution of credit market instruments willhave to be tried to achieve greater realism.
APFRAI.SAI.
Table II shows the implications of the flows specified previously forthe balance sheets of the private domestic sectors. Except for an unusually
E large and continuing accumulation of government securities by thebusiness sector, particularly from 1976 to 1977, and a correspondinglysmall increase in the holdings of commercial banks, the distribution ofgovernment debt appears quite reasonable. Given that the Federal deficitis projected to decline only gradually from the recent high levels, the per-
5The components of the miscellaneous and some other categories are so diverse thatprojections are entered only to indicate the rough orders of magnitude expected in thepresent expansion on the basis of past movements in the aggregates. For all historical datasee Board of Governors of!he I:edcrat Reserve System. Flow ol Funds Accounts /945 -197LAugust 1973 and subsequent publications. Data content and sources are explained in Boardof Governors of the Federal Reserve System. Introduction to Flow of Funds. February 1975.pp. 34-48; and Flow of Funds Accounts-Data Sources and Derivations. October l97L
own forecast provides flow-of-funds components for the nonf,nancjl Sectorsbut these estimates are riot used because they cannot be reconciled with the net investmentin credit market and related instruments previously derived in this paper. See Allen Sinai,"Flow-of-Funds, A Solid Financial Recovery for Business," The Data Resources Review.May 197, pp. 74 83.
19
TA
BLE
11
YfA
K-E
f) L
iQci
i) A
ssi u
s A
Nt)
IOT
A!
}'iN
A\(
IAI
Ass
i is
Oi 1
ST
\\f>
IN(;
ay
Si'C
TO
KS
,A
NN
UA
L R
AT
ES
OF
GR
OW
TH
AN
D R
ELA
TE
D D
AT
A.
1972
-77
1972
973
1974
-19
7519
76j9
17
Hou
seho
lds
Tot
al L
iqui
d A
sset
s (S
bill
ion)
Gro
wth
Rat
e(P
ercc
nt)
Tot
al C
ash
Ass
ets
Gro
wth
Rat
e (P
erce
nt)
Dem
and
Dep
osits
and
Cur
renc
yT
ime
and
Sav
ings
Dep
osits
U.S
. Gov
ernm
ent S
ceur
ittes
Tot
al F
inan
cial
Ase
ts'
Liqu
id A
sset
Rat
io (
Per
cent
)
81.1
12.1
472
5.2
13.6
715
7.3
567.
985
.914
46.7
56.0
7
911.
112
.33
805.
811
.13
170.
263
5.6
05,3
1557
.958
.48
994.
39,
1387
3.9
8.45
78.9
695.
012
0.4
1667
.059
.65
1093
.5 9.98
973.
911
.44
187.
178
6.8
119.
618
46.2
59.2
3
1222
.611
,81
1101
.313
.08
204.
389
7.0
121.
320
15.9
60 6
5
I 358
911
.15
1225
.711
.30
2224
1003
.313
3.2
2200
,063
77
Gro
wth
Rat
e oI
PC
EB
usin
ess
11.0
98.
509.
2810
.62
10.9
310
31
Tot
al L
iqui
d A
sset
sD
eman
d D
epos
its a
nd C
urre
ncy
Tim
e ar
id S
avin
gs D
epos
itsU
.S. G
over
nmen
t Sec
uriti
esT
otal
Fin
anci
al A
sset
sLi
quid
Ass
et R
aiio
(P
erce
nt)
83.0
55.6
20.2
7.2
476.
117
.43
82.3
55.4
23.5 5.4
528.
015
.59
92.8
55.8
28.1 8.9
580.
116
00
07.3
57.9
24.5
25.1
621.
517
.30
126.
858
.924
.043
,968
9.8
8.38
160.
660
.431
.069
278
4 1
20.4
8
Sou
rce:
Boa
rd o
f Gov
erno
rs o
f the
Fed
eral
Res
erve
Sys
tem
for
the
year
s 19
72 7
5. T
able
s h(
liqui
d an
d in
sura
nce
asse
ts)
and
9 (c
recI
t mar
kci a
s-se
ts a
nd r
elat
ed a
sset
s ex
clud
ing
corp
orat
e sh
aros
) fo
r 19
76. a
nd T
able
s 7
and
10 fo
r 19
77.
5Cor
pora
te e
quiti
es a
re e
xclu
ded.
bGro
m,,t
h ra
tes
durin
g ca
lend
ar y
ears
are
cal
cula
ted
from
the
DR
I for
ecas
t of f
low
s or
sto
cks
at s
ucce
ssiv
e yc
aren
ds w
hich
are
est
mat
ed a
s th
eav
erag
e of
the
valu
es fo
r th
e tw
o qu
arte
rs s
urro
undi
ng th
e tu
rn o
f eac
h ye
ar. G
row
th r
ates
of t
he m
onet
ary
aggr
egat
es fr
om 1
97! t
hrou
gh 1
974
are
from
Dec
embe
r to
Dec
embe
r bu
t the
follo
win
g va
lues
wer
e us
ed fo
r th
year
cnd
mon
ey s
tock
at t
he e
nd o
f 197
5 fo
rM th
roug
h M
. res
pect
ivel
y(in
bill
ions
): $
295,
$66
5, $
1094
, $74
8, a
nd S
I 177
.
Com
mer
cial
Ban
ksU
.S. G
over
nmen
t Sec
uriti
es90
.088
889
.812
0.1
146,
415
0.2
Tot
al F
inan
cial
Ass
ets
655.
075
5.2
839.
687
2.5
953.
805
1.4
Rat
io (
Per
cent
)13
.74
11.7
610
.70
13.7
7L5
.35
14.2
9
Non
bank
Fin
ance
U.S
. Gov
ernm
ent S
ecur
ities
50.4
52.4
58.2
84.9
103.
410
8.4
Tot
al F
inan
cial
Ass
ets5
829.
790
4.0
975.
210
75.9
1183
.112
87.5
Rat
io (
Per
cent
)6,
075,
805.
977.
898.
748.
42
Gro
wth
Ra,
sbG
NP
12.0
09.
635.
5610
.93
12.1
210
.87
M1
9.20
5.95
4.66
4.20
7.66
6.99
M2
11.3
68.
787.
188.
5911
.31
9.78
M3
13.3
98.
836.
7511
.45
12.6
110
.46
M4
12.6
511
.60
10.6
06.
529.
5710
.37
M5
14.1
410
.64
8.99
9.86
11.4
110
.80
centage of financial assets invested in government securities must rise hutthe business sector appears to absorb an inordinately large portion of theI j / rise. This together with the unusually large liquid asset ratio shown inTable II casts doubt on whether business will borrow as much as pro-jectcd through the issuance of corporate bonds.Households
also increase their liquid asset ratios persistently from1975 to 1977, with total cash assets growing very much 1tster than personalconsumption expenditures (PCE) for three successive years. Given the netfinancial investment of the household sector, that sector must finance theacquisition of unusually large additions to liquid and insurance claimsthrough much greater borrowing in the credit markets than in 1975. Eventhough the projected strong rise in the purchases of consumer durablesand homes will require increased consumer and mortgage credit, the addi-lions shown in Tables 9 arid 10 appear quite high.'7 Having used onlyDR l's NIA forecast and specified money growth rates to derive an in-dependent flow of funds translation, it appears therefore that the esti-mated liquidity of households and businesses may be higher than wouldbe consistent with the forecast.
Assuming this observation is well-founded from a Spring 1976 per-spective, we can now proceed to illustrate how elements of either the NIAforecast or the flow of funds translation can be changed to make the twomore consistent. There are basically two ways to proceed. One can either
4 accept DRI's money supply assumptions and raise the projected growthrates of private expenditure components such as PCE and BFI. Thiswould reduce the estimated liquidity ratios and justify the high loan de-mand through additional inflation or real growth. Alternatively, one canargue that the DRI income and product forecast for 1976 and 1977 can berealized with considerably lower money growth rates than DRI assumed.Since liquidity is high and DRI's growth rates for M, and M2 are abovethe 7 percent and 10 percent limits of the respective target ranges an-nounced by the Federal Reserve Board Chairman in April of 1976. thislatter course will be followed here.
Reducing the growth rates of M,, M, and A'13 by roughly one per-centage point in 1976 lowers the investment in credit market and relatedinstruments by about $6 billion by banks and $6 l)illion b' nonbankfinancial institutjoris in 1976. Correspondingly, households are assumed to
7The DRI forecast suggests an 8 percent rise in purchases of consumer durablesduring 1976, and the $32 billion net increase in consumer credit shown in Table 9 wouldproduce almost the same percentage increase in consumer credit outstanding However,since the replacement value of the stock of consumer durables will rise by considerably lessthan 8 perccnt the assumed expansion of consumer credit may well be high. About $445billion home mortgage credit to households was outstanding at the end of 1975, so that the556 billion rise in homemortgage credit appears less excessive in view of the over 10 percentrise in the median selling
price of homes expected in 1976 and the increase in the nunihcrof sates of both new and existing homes.
22
S
TA
BL
E 1
2F
LOW
OF
FU
ND
S M
onIn
cArlo
Ns
WIT
H S
LOW
ER
GR
OW
TH
OF
TH
E M
ON
ET
AR
Y A
GG
RE
GA
TE
SA
ND
TH
E F
INA
L A
PP
RO
XIM
AT
ION
(S b
illio
n)
aFro
m T
able
II.
hCilt
d w
ith f
low
of
fund
s m
odif
icat
ions
sho
wn
abov
e.
1976
1977
Tra
nsac
tion
Cat
egor
yU
SU
SU
SU
SU
SU
SU
SU
SA
ccou
ntin
g O
ffse
t for
net
inve
stm
ent i
n cr
edit
mar
ket
and
rela
ted
inst
rum
ents
+12
-6-6
+6
-3-3
Cre
dit m
arke
t ins
trum
ents
-12
-2-2
-6-6
-6-4
-4-3
-3U
.S. g
over
nmen
t sec
uriti
es-2
+2
-4+
4C
orpo
rate
and
for
eign
bon
ds-2
-1-1
-4H
ome
mor
tgag
es-6
-3-3
-3-3
27. C
onsu
mer
cre
dit
-6-4
-2-3
-4+
1
(Liq
uid)
Ass
et R
atio
(Pe
rcen
t)In
itial
App
roxi
mat
iona
60,6
518
.38
15.3
58.
7461
.77
20.4
814
.29
8.42
Fina
l App
roxi
mat
ionb
60.4
118
.14
15.6
68,
7861
.45
19.8
714
.98
8.48
Priv
ate
Priv
ate
Cor
n m
erc
ia I
Non
ban
kC
omm
erci
alN
on
bank
Sect
orH
ouse
hold
sB
usin
ess
Ban
ksFi
nanc
eH
ouse
hold
sB
usin
ess
Ban
ksFi
nanc
e
I
acquire S3 billion less demand deposits and 9 billion less time and savingsdeposits. The resulting l2 billion reduction in household borrowingcredit market and related instruments is assumed to he equally dividedbetween home mortgages and onumer credit, as shown in Table 12,leading to matching reductions in assets acquired by the private fInancialsectors. The nonfinancial business sector is assumed to issue fiwer cor-porate bonds and to acquire a smaller amount of U.S. government Securi-ties, while commercial banks increase their acquisition of governmentsecurities compared to the initial approximation in Table 9. Similar ad-justments are made in 1977, except that money growth is reduced by onlyabout one-half percent for the first three aggregates shown in Table I
Table 12 also shows the liquid asset ratios or U.S. government Se-curity ratios that result from these adjustments in the fInal approxinlatjo,iWhile the liquid asset ratios for households and business are lower in l97iand 1977 than in the initial approximation, these liquidity ratios are stillconsiderably higher than in 1972-73. Thus, they appear to be quile suf-ficient to support a GNP forecast similar to that of i)R I even though bothM1 and M2 velocity grow faster than at comparable stages of previous
It must be emphasized however that this exercise in judgment is in-tended only to illustrate the possible usefulness of attempting fiow-offunds reconciliations and not to criticize the I)R! forecast. The generaleconomist will gain additional insights by not restricting himself to thestudy of the implied velocity of money as the only financial check on theplausibility of a forecast. Using the specified growth in the liabilities of thefinancial sectors in conjunction with the net financial investment derivedfrom an NIA forecast as starting points for a flow of funds reconciliationallows researchers to assess a much broader range of relationships underthe discipline of an accounting framework.
To this analyst the exercise has suggested that there is nothing in theDRI forecast to give substance to fears of financial crisis in either 1976or 1977. In fact, liquidity is growing so rapidly in the private sector thatconsiderably lower rates of monetary expansion than assumed by DRIcould be entirely consistent with their GNP forecast. Thus, there may beno visible signs of crowding-out from government deficits, at least until1978.
8The increase in the amount of large certificates of deposit outstanding is the sameas implied by Table II: S3.6 in 1976 and -t-$l2.6 in 1977. In 1977, the increase of Mis reduced by Sl.5 billion and of M2 by S3 billion, yielding money stock of 5335.3 and3803.6 billion respectively, at the end of 977.lausing December to December growth rates for monetary aggregates and averages ofquarterly values around Vcarends for calculating (NP grossth. thc risc in velocits ssas2 ô2° and 2.57, during 1971 and 1972, respectively compared to an estimated 5 I 3° and4 02 in 1976 and 1977. Similarly, he M2 velocity growth rates of - I 9l'0 and 0 57 inthe earlier period are well below the later rates oil .55° and 1.29,.
24
6II
h'is
1-
a I
t'ie
heed)fl
ler
he76at
RIbe
itil
,tflIC
and
s ofvs as
andin
At the present time, forecasts of credit and of financial flows that areintegrated with the forecasts of income and product flows are as yet rare.Unfettered by the need for consistency, disagreements have been sub-stantial about the likely impact of large Federal deficit financing on themoney and credit markets in 1975 and beyond. A more orderly discussionof credit market prospects could begin if alternative judgments were pre-sented in a systematic framework allowing a more complete appraisal.
This paper shows that, as a minimum, the sources and uses of grosssavings and the growth in the deposit and insurance liabilities of financialinstitutions and of the corresponding assets which are held mainly by non-financial agents must be specified by sector. The balance of net invest-ment in credit market and related instruments that results for each sectormust then he met in estimating the gross flows of funds in the creditmarket.
The sequence of simple tables laid out in this paper is designed to il-lustrate the derivation process and to show how hypotheses about allegedfinancing problems or forecast inconsistencies can be tested systematically.While this is done with the April 1976 control solution of DRI, the pro-cedure is quite general and can be followed in the how of funds transla-tion of any other forecast that detils the required NIA components andthe money supply.
A inerican Enterprise institute
Subniiiied April 1975
revised June 1976
Co N CI.0siON
25