Abstract

The purpose of this workshop is to show how income and financial transactions undertaken in a modern economy, divided into economic sectors according to type of activity or pattern of behavior, can be organized and summarized conveniently in a set of interrelated accounts. The usefulness of setting up a flow-of-funds system lies in the fact that it describes the financing of the various sectors of the economy and the categories of market instruments used in financial transactions. Such a system brings out explicitly the important macro-economic accounting identities that aid in the formulation of behavioral hypotheses; and it helps in the design and control of development plans, as well as in the design and checking of consistency of short-run financial programs.

The purpose of this workshop is to show how income and financial transactions undertaken in a modern economy, divided into economic sectors according to type of activity or pattern of behavior, can be organized and summarized conveniently in a set of interrelated accounts. The usefulness of setting up a flow-of-funds system lies in the fact that it describes the financing of the various sectors of the economy and the categories of market instruments used in financial transactions. Such a system brings out explicitly the important macro-economic accounting identities that aid in the formulation of behavioral hypotheses; and it helps in the design and control of development plans, as well as in the design and checking of consistency of short-run financial programs.

The workshop consists of two sections. In the first section, the basic structure and the analytical uses of the flow-of-funds accounts are briefly explained, and there follows a discussion of the use of data from the monetary survey, government finance statistics, and balance of payments statistics in the construction of the flow-of-funds accounts. An exercise involving the construction of current transactions accounts and balance sheets of a hypothetical economy is also part of this section. The second section deals with the construction of an elementary summary of a flow-of-funds account for Kenya on the basis of 1976 data from various official sources. This section also includes a number of issues for discussion.

FLOW-OF-FUNDS ACCOUNTS

Basic Structure and Analytical Uses

For convenient presentation of flow-of-funds accounts, the economy of a country may be divided into five sectors: households (PSH), private business firms (PSC), the government sector (GS) the banking sector (B), and the foreign sector (FS). Each sector is engaged in income and expenditure, as well as financial, transactions. Thus, from the viewpoint of flow of funds, the statement of the transaction account of a sector comprises two parts. The first part registers the sources of funds, which consist of the receipts from the sale of goods and services currently supplied and transfers; it also records the uses of these funds, such as the purchase of goods and services. The second part registers the receipts from the sale of financial claims, or the assumption of financial liabilities and the outlays on the acquisition of financial claims, or the repayment of financial liabilities. In presenting the accounts, the banking sector is considered to be confined to financial transactions only. As a financial intermediary, it creates financial liabilities for the other sectors to hold as their financial assets by borrowing from them, and it acquires financial assets from other sectors by lending to them; its own relatively small income-expenditure transactions are included in other sectors. Typically, the five sectoral accounts resemble those in Tables 15, which can be consolidated in a summary account, as shown in Table 6.1 All flows and all stock changes in the sectoral accounts are cash transactions. The accounts do not show accrual items in respect of which cash payments are due but have not yet been effected.

TABLE 1.

Transactions and Changes in Balance Sheet: Household Sector (PSH)

(In units of account)

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See text for explanation of abbreviations.

As explained earlier in this section, net financing is the difference between items II (1) and II (2); it is also equal to item I (5).

TABLE 2.

Transactions and Changes in Balance Sheet: Business Firms Sector(PSC)

(In units of account)

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Note: X = C5 + I5.

See text for explanation of abbreviations.

TABLE 3.

Transactions and Changes in Balance Sheet: Government Sector(GS)

(In units of account)

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Note: G = C3 + Y31 + TR + M3 + I3S3 - I3 = T-G.

See text for explanation of abbreviations.

TABLE 4.

Changes in Balance Sheet: Banking Sector (B)

(In units of account)

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Note: Change in domestic credit (ΔNDC) = Δ(B/PS) + Δ(B/GS).

See text for explanation of abbreviations.

TABLE 5.

Transactions and Changes in Balance Sheet: Foreign Sector (FS)

(In units of account)

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Note: C5 + I5 = XS5 - I5 = M - (X + Y51).

See text for explanation of abbreviations.

As explained earlier in this section, the overall surplus of the foreign sector is treated as use while that of the domestic sectors (Tables 1 to 3) is treated as source, since the overall position for the economy as a whole (including the foreign sector) is zero.

TABLE 6.

Summary of Income and Flow-of-Funds Accounts1

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Note: See text for explanation of abbreviations.

The overall sector position, shown in Part I of the accounts, indicates a nonfinancial deficit or a nonfinancial net saving, depending on whether it is negative or positive, respectively. The amount of such deficit or net saving in a sectoral account should be equal to the amount of net financing shown in Part II of the same account. This means that a nonfinancial deficit of a sector will result in an increase in its financial liabilities or a decrease in its holdings of financial assets—and vice versa in the case of a nonfinancial saving. The composition of the holdings of financial assets or liabilities of a sector can be changed as long as the net change is equivalent to the sectoral saving or deficit.

Since the expenditures of one sector are the incomes of others, the sum of all sectoral nonfinancial receipts (i.e., all domestic incomes, plus imports, plus all transfers received) equals the sum of all sectoral expenditures (i.e., all consumption expenditures, plus all investment expenditures and all transfers paid by both domestic and foreign sectors). It should be noted that imports are treated as outlays of domestic sectors and receipts of the foreign sector and that exports are considered as outlays of the foreign sector and receipts of domestic sectors. It follows that, for the economy as a whole, including the foreign sector, the overall position is zero, ex post:

Σi=1S(SiIi)=0

Given the vertical balance between total saving and total investment and the horizontal balance between payments and receipts, “each column and each row [in Table 6] constitutes one full account of the structure, and the relationships among columns, among rows, and between columns and rows express the interlocking nature of the accounting system as a whole.” 2

Because of the interlocking nature of the system, if the incomes of a sector change during an accounting period, not only that sector’s expenditures or its overall position will change, but other sectors will also show corresponding changes. Furthermore, a change in the position of a sector-surplus or deficit-is related to changes in the amount and possibly in the composition of financial assets or liabilities held by the sector. Corresponding adjustments can be found in other sectors. Similarly, a linkage within the sector or between sectors can be traced if a change originates in the holding of a certain financing instrument in a sector. For example, an increase in government investment I3 may be financed by an increase in net borrowing from the banking sector Δ(B/GS), which may decrease the availability of bank loans to business firms Δ(B/PSC), given the total amount of domestic credit of the banking sector. The decrease in Δ(B/PSC) may then lead to a decrease in business investment I2. The flow-of-funds system itself does not indicate the cause and effect of the above adjustments. However, behavioral hypotheses can be investigated within the framework of this accounting system, and different adjustment patterns have different implications for policies.

The equality between the nonfinancial deficit or the nonfinan-cial net saving, as the case may be, and net financing for each sector, as mentioned above, can be expressed by the following identities:

I1S1=Δ(B/PSH)Δ(PSH/B)Δ(PSH/GS)Δ(PSH/PSC)(1)
I2S2=Δ(PSH/PSC)+Δ(B/PSC)Δ(PSC/B)Δ(PSC/GS)+Δ(FS/PSC)(2)
I3S3=Δ(PSH/GS)+Δ(PSC/GS)+Δ(B/GS)+Δ(FS/GS)+Δ(FS/PSC)(3)
Δ(PSH/B)+Δ(PSC/B)=Δ(B/PSH)+Δ(B/PSC)+Δ(B/GS)+Δ(B/FS)(4)
I5S5=Δ(FS/B)+Δ(FS/PSC)Δ(FS/GS)(5)

Alternatively, where PSH and PSC are consolidated into private sector (PS), the identities can be rewritten as:

IPSP=ΔDCP+CMPΔ(PS/GS)ΔMQ(6)
GT=ΔNDCG+Δ(PS/GS)+CMG(7)
ΔMQ=ΔNDC+ΔNFA(8)
ΔNFA=XM+CM+NFI(9)

The new symbols are defined as follows:

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Equations of this type may be included in financial models. An example is the Polak model,3 which will be discussed in “The Polak Model: An Application” (Workshop 5). It may be argued that changes in the composition of a sector’s portfolio in any period depend in part on the amount of readily available funds, which may act as a short-run constraint. It follows that expected flows of funds may influence sectoral behavior, whether financial or nonfinancial.4

A financial program may be conceived of as the numerical projection, for the program period, of a flow-of-funds table, which could be linked to a complete matrix of the national accounts. Given the targets of the program, nonfinancial savings or deficits of the economic sectors are first estimated, together with their financing requirements. It would then need to be determined (1) whether these two sets of estimates are consistent with each other among sectors; and (2) whether the banking sector could be induced to mobilize the available savings from the surplus sectors and transfer them, through the creation of appropriate claims, to the deficit sectors, in consistency with the targets set in the program.

Flow-of-funds accounts can also be used in the design and control of development plans. A development plan consists essentially of the control of the flow of available real resources, aiming toward investment to achieve economic growth. The information provided in the flow-of-funds accounts for successive periods of time is useful in determining feasible investment targets for the economic sectors and for the economy as a whole. The relationship between the financing needs of the economic sectors and their expenditures as indicated in the flow-of-funds accounts also suggests the possibility of using financial controls for the implementation of a development plan.

Relations with the Monetary Survey, Government Finance Statistics, and Balance of Payments Statistics

Many countries do not have a comprehensive system of flow-of-funds accounts, in part because of a lack of requisite information. In most cases, data on private sector saving, investment, and financing are so fragmented that the PS columns in the summary account of flow of funds are difficult to fill. Nevertheless, a part of this information gap can be closed by making use of the monetary survey, government finance statistics, and balance of payments statistics, which are generally available. These data are normally compiled with considerably shorter delays and at more frequent intervals than national income data. The crucial problem is that of achieving an adequate and consistent allocation of the data by sector. In order to show the intersectoral relationships as in a flow-of-funds system, changes in assets and liabilities in these accounting sources must be allocated by sector according to consistent criteria, so that flows originating in one sector and directed to another (as shown in the first sector’s statement) are consistent with flows recorded in the second sector (as directed to it from the first).

The monetary survey is a consolidated statement of the banking system, i.e., the monetary authorities and deposit money banks. It does not include other financial intermediaries. In this classification, the nonbank financial intermediaries are lumped together with the private sector. Similarly, when government finance statistics are available only for the central government, municipal and local governments and public enterprises are classified with the private sector. Furthermore, in terms of data classification, there are differences between national income accounts, on the one hand, and balance of payments statistics and government finance statistics, on the other.

The sectoral position for the foreign sector (X - M), which represents net lending to the rest of the world in the national income accounts, is not identical to the net balance on current account in the balance of payments.5 Among other differences, net lending in the national income accounts classification (1) includes the net purchases of nonfinancial intangible assets, such as leases, (2 excludes earnings reinvested in direct investment enterprises, and (3) excludes shipments of commodities between a parent enterprise and its subsidiary that do not involve a change of ownership. In the balance of payments, (1) net purchases of nonfinancial intangible assets are included in the capital account, (2) the direct investors’ share of reinvested earnings is shown as investment income and is balanced by entries in the capital account, and (3) shipments of commodities between a parent enterprise and its subsidiary without a change of ownership are included with merchandise.

Expenditures and revenues of the government in the national income accounts are not identical to those reported in the government finance statistics. A significant difference is that national income accounts adhere to an accrual basis of recording, reflecting production and delivery, whereas transactions in the government finance statistics are recorded on a payments basis. Other major differences are: (1) resources representing past or future transactions, such as consumption of fixed capital and imputed contributions to unfunded pension schemes, are excluded from the government finance statistics while they are included in the national income accounts; (2) government lending operations undertaken for public policy purposes are classified with expenditure in the government finance statistics rather than with financing (as in national accounts); and (3) banking and monetary authorities’ functions performed by government are separated from government in the government finance statistics, while they are grouped with government in the national accounts.6

When consistent allocation by sector is made and data are classified appropriately, the monetary survey, the central government budgetary operations, and the balance of payments summary can be used in the columns for B, GS, and FS in the summary of flow-of-funds accounts (Table 6). Part of the column for PS, i.e., a consolidated account for PSH and PSC, can then be filled in, even without the national income accounts pertaining to the sector.

National Income Accounts and Flow of Funds of a Hypothetical Economy

The following statistical data on current and financial transactions are assumed for a hypothetical economy during a certain year (year n).

1. The household sector spent $9,700 million on consumption and $100 million on housing. Income tax payments amounted to $2,000 million. When the financial transactions of this sector were consolidated, it was found that its currency holdings had increased by $30 million and its deposits with banks had risen by $250 million. Moreover, household holdings of market instruments had risen by $120 million, of which $70 million were in corporate stocks and the remainder were in government bonds. Borrowing from banks had increased by $100 million.

2. The corporate sector received $450 million from intra-sector sales of investment goods, $3,100 million from sale of goods and services to the government, and $4,250 million from exports of goods and services. On the other hand, this sector paid $11,100 million to household units for factor services and spent $4,700 million on imports; tax payments to the government amounted to $1,500 million. Its financial assets increased by $450 million ($410 million in demand deposits and $40 million in holdings of government bonds), and its financial liabilities to banks rose by $530 million.

3. The government sectors net tax receipts were insufficient to cover expenditures amounting to $2,900 million on current account ($1,000 million for wages and salaries of government employees and $1,900 million for consumption goods and other services) and $1,200 million on capital goods. In view of the financing requirements, the government issued treasury bonds, which were sold to the public, and borrowed $510 million from the banking system.

4. The foreign sector incurred current expenditures (hypothetical economy’s exports) equal to $4,000 million, whereas its receipts (hypothetical economy’s imports) amounted to $4,700 million. In addition, this sector spent $250 million on investment expenditures. The credit balance that resulted from these transactions was reflected in a credit entry on the consolidated balance sheet of the hypothetical economy’s banking system.

5. The balance sheet of the banking sector, i.e., the central bank and the commercial banks, recorded the transactions shown in Table 7.

TABLE 7

Summary Balance Sheets of the Central Bank and the Commercial Banks of the Hypothetical Economy

(In millions of U.S. dollars)

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Note: See text for explanation of abbreviations.

EXERCISES

1. On the basis of the statistical information provided, construct account tables showing the current transactions and the balance sheet changes of each sector separately (similar to Tables 15).

2. Show how the constructed account tables can be grouped together to provide a summary of transactions of the hypothetical economic system (similar to Table 6).

NATIONAL ACCOUNTS AND FLOW OF FUNDS OF KENYA, 1976

Basic income and financial data for Kenya for the years 1975–76 are provided in Tables 814. Several points should be mentioned before the flow-of-funds accounts are compiled. First, since no separate data are available for the household and corporate sectors, the transactions of these two sectors vis-à-vis the other sectors of the economy are consolidated into one sector, i.e., the private sector. The format for the current transactions account and for changes in the balance sheet of the private sector is provided in Table 16. Second, insufficient information is available regarding the income and financial transactions of the local governments, other official entities, and the nonbank financial institutions. For this reason and from a practical policymaking point of view, the government sector includes only Budgetary Central Government, while the banking sector comprises the Central Bank and the commercial banks.

TABLE 8.

Kenya: Selected National Accounts Data, 1975–76

(In millions of Kenya shillings)

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Source: Kenya, Economic Survey, 1978.
TABLE 9.

Kenya: Summary of Central Government Budgetary Operations, Fiscal Years 1976 and 1977

(In millions of Kenya shillings; year ending June 30)

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Sources: International Monetary Fund, Government Finance Statistics Yearbook, Vol. 2 (Washington, 1978), and International Financial Statistics, various issues; Central Bank of Kenya, Annual Report for the Financial Year Ended30th June, 1977.
TABLE 10.

Kenya: Expenditure and Lending Minus Repayments by Economic Type for Budgetary Central Government, Fiscal Years 1976 and 1977

(In millions of Kenya shillings; year ending June 30)

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Sources: International Monetary Fund, Government Finance Statistics Yearbook, Vol. 2 (Washington, 1978); Kenya, Appropriation Accounts, Other Public Accounts and the Accounts of the Funds for the Year 1975/76 and 1976/77.
TABLE 11.

Kenya: Monetary Survey, December 1974-June 1977

(In millions of Kenya shillings)

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Sources: Central Bank of Kenya, Annual Report tor the Financial Year Ended 30th June, 1977; International Monetary Fund, International Financial Statistics, July 1978.

Foreign liabilities include use of Fund credit.

Foreign exchange holdings.

Includes Cereals and Sugar Finance Corporation and Agricultural Finance Corporation.

Adjusted for “uncleared effects.”

The domestic counterpart of Kenya’s SOR allocation was transferred in September 1975 to treasury deposits with the Central Bank of Kenya.

TABLE 12.

Kenya: Summary Accounts of the Monetary Authorities, December 1974-June 1977

(In millions of Kenya shillings)

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Sources: Central Bank of Kenya, Annual Report for the Financial Year Ended 30th June, 1977; International Monetary Fund, International Financial Statistics, July 1978.

Includes balances with banks abroad and foreign securities.

Includes use of Fund credit.

Includes revaluation account, uncleared effects, and other unclassified assets and liabilities.

The domestic counterpart of Kenya’s SDR allocation was transferred in September 1975 to treasury deposits with the Central Bank of Kenya.

TABLE 13.

Kenya: Summary Accounts of the Commercial Banks, December 1974-June 1977

(In millions of Kenya shillings)

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Sources: Central Bank of Kenya, Annual Report for the Financial Year Ended 30th June, 1977; International Monetary Fund, International Financial Statistics, July 1978.
TABLE 14.

Kenya: Balance of Payments Summary, 1976

(In millions of Kenya shillings)

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Sources: For the current account and the capital account (except commercial banks), the data are taken from Kenya, Economic Survey, 1978. The data for commercial banks and financing are taken from International Monetary Fund, InternationalFinancial Statistics, July 1978, in order to ensure consistency with the monetary accounts for purposes of financial programming (see Workshop 9: Financial Programming). The adjustment for the resulting discrepancy is contained in the residual item, Errors and omissions.Note: n.e.s. = not elsewhere specified.

Includes foreign banks’ deposits with the Central Bank of Kenya and International Monetary Fund deposits.

TABLE 15.

Kenya: Income-Expenditure and Financial Transactions, 1976

(In millions of Kenya shillings; at current prices)

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Numbers in parentheses refer to Tables 814.

These data represent changes in assets and liabilities of the private, government, and foreign sectors during 1976.

TABLE 16.

Kenya: Transactions and Changes in Balance Sheet of the Private Sector (PS), 1976

(In millions of Kenya shillings)

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Table 15 summarizes the relevant data on income-expenditure and financial transactions, as provided in Tables 814, for the compilation of flow-of-funds accounts for Kenya for 1976. Some adjustments have been made for the convenience of the compilation.

EXERCISES

1. On the basis of Table 15, construct the current transactions account and compute the saving or dissaving of each sector. The format of Part I of Tables 3, 5, and 16 will facilitate this work. Determine the overall balance or position of each sector.

2. Using the financial data in Table 15, show how each sector financed its deficit or disposed of its surplus, i.e., construct the balance sheet of each sector. The format of Part II of Tables 3, 5, and 16 can be used for this purpose. Note that the financial transactions data are given as changes in assets and liabilities between the end of 1915 and the end of 1976.

3. Construct the balance sheet of the banking sector, using Table 4.

4. Summarize the current accounts and balance sheets of all sectors in Table 17. Note that, apart from the consolidation of the household and corporate sectors into one sector,