Purpose of the method

The purpose of the method of monetary analysis which has been developed in the last few years in the Annual Report of the Nederlandsche Bank is essentially of a practical nature. It is meant to provide the Bank with a tool to help it in unraveling the mechanism of inflationary and deflationary disturbances and thus to aid the Bank in framing its policies.

I think that most of us will agree that it is one of the prime duties of central banks to prevent or at least to counteract—as far as is possible within the limits of their authority—any inflationary or deflationary developments of sufficient magnitude to create a threat to the long-run stability of the internal and external purchasing power of their monetary unit.

In order to be able to prevent or to counteract inflationary or deflationary developments, one must first be able to recognize them—and, if possible, to recognize them in their earliest stage. This may be done either by looking for the symptoms of their causes or for the symptoms of their effects.

Except in cases of gross monetary mismanagement, it has always been felt easier to recognize the effects of monetary disturbances than to clearly recognize their causes. We all agree that boom conditions, over-employment, increases in the price level, and balance of payments deficits—especially when showing up simultaneously—are indicators of internal inflationary disturbances, whilst underemployment, price falls, and balance of payments surpluses indicate deflationary conditions. Yet, when some of these symptoms contradict one another, we may feel less sure about the interpretation of our data, and even when agreeing about the observed effects we may find it difficult to agree upon their causes.

In the Netherlands, for example, the post factum analysis of the economic situation in 1953 led to very contradictory opinions about the monetary causes that had been at work. In the Annual Report of the Nederlandsche Bank, I myself concluded that a rather strong deflationary impulse emanating from the government sector had only partly been compensated by lesser inflationary pressures from the private sector, whilst their combined effect had been overcome by strong inflationary impulses from abroad, thus explaining the observed combination of mild boom conditions, increased employment, stable prices, and a rather big balance of payments surplus; however, Professor Witteveen, of the Rotterdam School of Economics, concluded on the basis of increased government expenditure and increased private investment that both government and the private sector of the economy had exerted a strong inflationary impulse, whilst the inflationary influences from abroad—judged by the increase in exports—had been rather negligible.

It is not difficult to imagine that the public showed itself rather flabbergasted by these contradictory opinions, and it took indeed some time before the core of the differences between the two authors had been thoroughly thrashed out in a very illuminating discussion, published in one of our leading economic periodicals.¹

This discussion proved that, within the limits of their own definitions and methods of approach, both authors from a formal point of view had been right in their contradictory conclusions.

To understand how this was possible one must be conscious of the fact that any quantitative analysis of economic phenomena has to be based upon a set of simplified suppositions with regard to the inter-dependency of the different factors which are to be observed. This set of simplified suppositions is what economists nowadays call a “model.” The simplification lies in the fact that on the basis of some presupposed rules of behavior—algebraically laid down in equations—a quantitative relationship between different phenomena is established. By considering only a limited number of factors to be open to “autonomous variations” and the others to be “dependent variables,” one is able, with the help of such a model, to predict the probable consequences of assumed variations in the autonomous factors.

Also, post factum, one is able, by linking the observed variations in the dependent factors to the observed variations in the autonomous ones, to allocate the “causes” of the variations in the former, albeit that to explain the post factum quantitative relationships one may have to introduce also some “autonomous” changes in the actual rules of behavior compared with the assumed ones.

The fun, but also the trouble, of this method is that one is always technically right. Not of course in predicting the future, but always in explaining the past. It is for this reason that one should beware of the fact that a model is nothing but a piece of man-made machinery. One can never get out of it what substantially has not been put into it beforehand.

The post factum analysis can only show as “causes” the factors which have been introduced as “autonomous variables” when framing the model. If, post factum, the observed changes in the autonomous factors cannot fully explain, i.e., quantitatively do not fit in with, the observed changes in the dependent ones, such divergences simply have to be attributed to some “autonomous” change in the equations of behavior. Reality is always right. Any consistent model can technically explain everything. The point is whether the explanation has any relevancy.

These considerations prove the importance of choosing one’s model, i.e., one’s method of approach to a problem. My controversy with Professor Witteveen made it clear that by inflation and deflation he actually meant increase or decrease in national income. Consequently, he sought the ultimate causes of inflation and deflation in variations in a set of factors, which he considered to be the only autonomous determinants of changes in national income, viz., government expenditure, private investment, and changes in exports. These autonomous changes in expenditure are linked with their multiple effect on the national income by way of the income multiplier, a constant to be derived from the propensity to save, the propensity to import, and the rate of taxation.

Professor Witteveen’s method of approach thus proved to be fundamentally of a nonmonetary nature. In the frame of his “model,” monetary policy in the sense of banking policy and central bank policy cannot find any place whatsoever, the provision of finance to enable entrepreneurs to carry out their autonomous investment decisions, and to enable Government to carry out its expenditure decisions, being implicitly supposed to adapt itself to demand.

It is clear that such a model cannot fit the purposes of a central bank. If one analyzes monetary phenomena with the purpose of getting some guidance for monetary policy, one must necessarily use a model in which monetary policy can find its place. If we believe that by monetary policy we can exert an influence on the creation of money, and maybe also on the propensity of the business community to hoard or to dishoard, and if we further believe that the exertion of such influence will affect the course of the inflationary or deflationary process, then, for the exposition of our ideas, we must choose a model in which the creation and cancellation of money and the acts of hoarding and dishoarding are treated as autonomous factors.

It is the purpose of the Bank’s method to provide the data for such a model.

Background of the method

The line of thought on which the Nederlandsche Bank has based its analysis of monetary conditions starts from the proposition that the essence of monetary disturbances is to be found in the possibility, created by the use of money, of exercising effective purchasing power in excess of, or in deficiency of, current contribution to production. This can be done only by financing expenditure out of the creation of new money or by drawing on available liquid reserves, or, reversely, by hoarding money or taking it out of circulation. Such financing is, in the terminology of the Bank’s Report, called an inflationary or deflationary method of finance.

Any inflationary monetary disturbance must be accompanied by money creation or dishoarding, i.e., by inflationary financing; any deflationary disturbance, by hoarding or cancellation of money, i.e., by deflationary financing.

It is important to see that this way of approach brings the problem of monetary disturbance back to the individual households.² Inflation is a problem of financing. It is the decision of individual households on how to finance their expenditure which is decisive for the occurrence or non-occurrence of a monetary disturbance. In a closed economy, such initial disturbance is connected with its multiple effect on production, income, and prices by way of the monetary multiplier; in an open economy also, the balance of payment effects have to be taken into consideration.

From the monetary point of view, these acts of spontaneous inflationary or deflationary financing must be considered as final causes. Even if, from a more general point of view, we may conclude that they are not quite autonomous, but that they themselves are motivated by other factors, we must consider them as final from the monetary point of view, because it is indeed the use of money that makes them possible and because it is our task as monetary authorities to concentrate on the problem of how to prevent, to restrain, to neutralize, to compensate, or, under certain very special circumstances, to stimulate them by the use of monetary policies.

Now we all know that, though banking statistics allow us to observe the sum total of the acts of creating and canceling money, we have no proper means of observing the acts of spontaneous hoarding and dishoarding. Worse still, even though, by observation of individual households, we may be able to observe spontaneous acts of hoarding and dishoarding, we may find it difficult to distinguish them from the acts of induced dishoarding and hoarding that are their necessary concomitants. As Robertson’s famous dictum says: All money that is anywhere must be somewhere. Newly created money, once introduced into the income stream, must be held by some household. How can we distinguish this induced increased holding of money, which forms a reaction to the inflationary process, from the spontaneous hoarding that must be interpreted as a deflationary impulse?

The analysis of the Nederlandsche Bank is based on the contention that by applying certain techniques we can indeed, to a certain extent, do so.

Any act of inflationary financing—and in order not to make my argument too involved I shall now leave out the case of an act of deflationary financing, which leads, of course, to reversed consequences—as I say, any act of inflationary financing leads somewhere else to an increase in income—which may be either real or only nominal—or to a temporary disinvestment. Both will be accompanied by an act of hoarding. But the type of hoarding will be different in these two instances.

The act of hoarding that accompanies a temporary disinvestment which takes place in reaction to inflationary impulses elsewhere is nothing but the expression of a delaying factor in the inflationary process. There is no reason why in a free market economy this type of reaction should be lasting. After a short period of transition, normal dispositions will again prevail. For the time being, this reaction may indeed impede the observation of the forces that are at work and lead us to underestimate the strength of the inflationary impulses. If our observations relate to a sufficient lapse of time we may, however, safely ignore this temporary reaction, unless it be stimulated by the application of direct physical controls. In the latter case, it will lead to the phenomenon of “latent” inflation which we well remember from the strictly controlled economies of the war years.

The acts of hoarding—in the sense of increase of average cash balances held—that accompany any increase of income and turnover are of a different type. They result from the increase in the need of money for transaction purposes which is the necessary concomitant of any increase in the real or nominal level of income and turnover. It is this absorption of money in the transaction sphere which eventually sets a limit to and consolidates the effects of the original inflationary impulse. Any new income, by being spent, tends to create additional income and would continue to do so if the money, created or released by the original act of inflationary financing, were not gradually absorbed by the need for increased cash balances.

It is this absorptive reaction to the inflationary process which is the only lasting one and which has to be separated from the total of observable impulses in order to gauge properly the strength of the inflationary forces that are at work. Such separation can very well be based on circumstantial evidence. If we see that during a period of expanding production the business community has been heavily relying on credit expansion and has, moreover, been running down its holdings of near-money, such as treasury bills and long-term bank deposits, we need not feel any doubt that any observed increase in its cash balances is not due to any autonomous hoarding, but is to be interpreted as a reaction to the existing inflationary development. On the contrary, we may have every reason to believe that a certain amount of autonomous dishoarding of inactive money has been adding to the inflationary impulses and has contributed to increase the amount of active money now being absorbed by trade.

A further problem which arises when observing the financing dispositions of the individual households is the question of the exact definition to be given to the notions of hoarding and dishoarding.

As soon as we recognize that the original monetary disturbance consists of the withholding of purchasing power by an act of hoarding or, contrarily, by the exercise of purchasing power coming from resources other than current income, we have to make up our minds about the interpretation of transactions in the financial field. There are three possible courses of action.

In the first instance, one may interpret any act of saving, if it is also accompanied by simultaneous financial investment, as an act of hoarding, and any financing out of funds obtained from others as an act of dishoarding. This interpretation would force us to call any and all saving deflationary, and any investment, except out of own current income, inflationary. In my opinion this terminology would be grossly misleading. The transfer of funds by way of the capital market from a party who chooses not to invest in realities himself, to another party who does, is so much part and parcel of the normal flow of funds, and has so little to do with what we recognize as actual or potential monetary disturbance, that it would definitely be misleading to interpret such transfer as a deflationary activity on the part of the lender and an inflationary activity on the part of the borrower that happen to compensate one another.

A second possibility would be to reserve the notions of hoarding and dishoarding to hoarding and dishoarding of money itself. This would mean that any transfer of purchasing power by transactions in the financial field would be considered as indifferent from the monetary point of view. At first sight this solution would seem perfectly logical.

On second thought we find, however, that this method of interpretation would have many disadvantages by covering up financing dispositions, which are of essential importance in the analysis of inflationary and deflationary processes, and by forcing us to attribute different meanings to financing dispositions which in the eyes of the individual households themselves are perfectly equivalent.

The Nederlandsche Bank has therefore chosen a third possibility, by applying the notion of hoarding and dishoarding—and consequently the notions of deflationary and inflationary financing—not only to the act of hoarding and dishoarding of money itself, but also to the act of accumulating or running down liquid reserves in the form of certain types of near-money, the so-called secondary liquidities, i.e., short-term claims on the Government, local public authorities, and money-creating institutions.

Its reasons for doing so are the following: In the first instance, one must recognize that secondary liquidities, although they cannot directly be used as a means of payment, and therefore lack one essential function of money itself, are, for all practical purposes, equivalent to money in its function as a store of value. Consequently, there is not much sense in applying the notions of liquidity preference, of hoarding for reasons of the precautionary or the speculative motive, etc., exclusively to money itself. We are much nearer to reality, i.e., to the considerations that motivate the individual households, by applying these notions to the sum total of primary and secondary liquidities.

For a business concern of some magnitude, it is a matter of slight interest differentials whether to keep its liquid reserves in a current account balance, in a short-term bank deposit, or in treasury bills. If it decides not to reinvest for the time being the amounts accumulated on depreciation account—and that is one of the essential deflationary impulses that may originate in the private sector—then it may decide on either one or the other. On the other hand, it would not dream—at any rate not in the Netherlands—of investing its liquid reserve in bonds or in the stock market.

It is therefore quite proper to register the accumulation of money, of bank deposits, or of treasury bills as one and the same act of hoarding. Of course, if the accumulated treasury bills do not come out of the stock of treasury bills held by the banking system, in which case a clearly deflationary cancellation of money takes place, but are directly bought from the Treasury, and if the Treasury uses the money thus obtained for current expenditure, then indeed there need not be any net deflationary disturbance. In that case, however, it is much more illuminating, and therefore more relevant, to interpret this joint transaction as a deflationary development in the private sector, compensated by an inflationary development in the government sector, than to pass it over as a transaction that, from the monetary point of view, could be considered indifferent. For even if no actual monetary disturbance has taken place, a potential one has been created. When, some time later, the private sector decides to reinvest and forces the Treasury to repay its short-term debt, the Treasury in all likelihood will have to fall back on the banking system to meet its liabilities.

It is important to recognize that the impulse for this creation of money has originated in the private sector, even though we may find it necessary to insist that it is up to the Government to compensate this inflationary impulse by some deflationary financing of its own.

A second reason for the Nederlandsche Bank’s extension of the notion of hoarding and dishoarding to secondary liquidities follows from the first. It is the fact that this interpretation allows a better, i.e., a more illuminating, allocation of the responsibility for inflationary and deflationary developments to the separate sectors of the economy.

A possible objection to the applied method is that, though it may be admitted that it is indeed difficult to draw a clear line of distinction between money and secondary liquidities, the same holds true for the distinction between the claims we do and those we do not include in the notion of secondary liquidity. Why, one might ask, include treasury bills in the first category but not short-term treasury bonds? The answer is that this objection is perfectly correct but that not too much importance should be attached to it. There generally are no sharp lines of distinction in practical life. Yet we have to draw them the best we can, the distinction of categories being an indispensable tool for any analytical thinking.

It may indeed very much depend upon local circumstances where the line has to be drawn between what is to be considered as secondary liquidity and what is not. The essential point is that only short-term debts of Government and money-creating institutions can properly be considered as falling in this category. For the essential difference between secondary liquidities and other relatively liquid claims is that the latter can be converted into actual money only by withdrawing purchasing power from the debtor or from some party who is willing to substitute himself for the creditor, whilst the owner of secondary liquidities can, for all practical purposes, force the debtor to create new money, because that debtor is either a money-creating institution, which has only to credit the owner of the claim on current account, or the Government, which would rather find some way to create new money than default on its debts.

Technique of the method

After these preliminaries about the basic ideas behind the method of analysis of the Nederlandsche Bank, the method itself is easily described. It consists of splitting the economy into separate sectors, so as to get as near as possible to what is happening in groups of individual households, and then to register the use of inflationary or deflationary methods of finance in each sector separately. Thus the Bank distinguishes (1) Central Government, (2) Local Authorities, (3) Institutional Investors and Miscellaneous Funds, (4) Capital Market and Sundry Items, and, finally, as a residual item (5) Private Individuals, Trade, and Industry. By using sample survey techniques, which the Nederlandsche Bank so far has not done, one might carry this sectional split still further, particularly for distinguishing between private households and entrepreneurs.

For each separate sector, the total amount of ascertainable net deflationary or inflationary financing is calculated. This total finds expression in the ascertainable liquidity surplus or liquidity deficit of the group. In a closed economy, the sum total of all liquidity surpluses and liquidity deficits must of necessity be zero. In an open economy, the sum total is equivalent to the national liquidity surplus or deficit, i.e., the balance of payments surplus or deficit. This surplus or deficit can again be interpreted as a deficit or surplus of a sixth sector of the economy, namely, the sector Foreign Countries.

Now, for most sectors, the ascertainable liquidity surplus or liquidity deficit can be taken as a direct measure of the net deflationary or inflationary impulse that has originated in that sector. For all practical purposes it is only in the sector Private Individuals, Trade, and Industry and in the sector Foreign Countries that the difficulty arises of properly distinguishing between financing dispositions that have to be interpreted as autonomous causes of the inflationary or deflationary processes and those dispositions that have to be interpreted as the unavoidable effects of such processes.

As I have explained before, it is—when observing a period of sufficient length—only the increase or decrease of cash holdings as a result of the transaction motive which has to be separated from the other acts of inflationary or deflationary finance and has to be interpreted as a reaction to, instead of as a cause of, the inflationary or deflationary process. Now, practically, we can say that this reaction will take place only in the sector Private Individuals, Trade, and Industry, where almost all the transaction money is being held. It is only in this sector, therefore, that the observed liquidity surplus or deficit has to be corrected for the likely change in transaction cash balances in order to arrive at an estimate of the net inflationary or deflationary impulses that have originated in this sector. Circumstantial evidence will easily give us a clue, if not to the exact magnitude, then at any rate to the direction of this reactive factor.

A second field in which we have to beware of the impulsive or reactive character of the observed liquidity surplus or deficit is in relation to foreign countries. The national liquidity surplus, i.e., the balance of payments surplus, can be just as well a reaction to the sum total of deflationary impulses that have been active internally as a measure of the inflationary impulses that have been working on the country from the outside. Here again, circumstantial evidence will have to help us in determining and interpreting the exact character of the observed facts.

The value of a scientific tool, such as an analytical method, can be judged only by the use that can be made of it. It is only when it helps us to understand better the relationship of things, to come to relevant conclusions about their interaction, and, if possible, to devise improved rules of conduct, that we have reason to prefer one method of description to another.

In this connection, it is important to know that the Nederlandsche Bank has not arrived at its method of analysis out of some theoretical deduction, but that this method has grown out of dissatisfaction with the results obtained from a previous analytical approach. This previous approach was the well-known technique of determining the causes of the changes in the volume of money from the combined balance sheet of the banking system. This technique was followed by the Bank up to 1950. But especially in the year of the Korea crisis with its terrific inflationary pressures, it proved itself quite inadequate both to explain clearly what was happening and to provide monetary policy with proper rules of conduct. It was therefore in 1951 that the Bank started with what is considered an improved analysis, which was then further developed in the ensuing years.

To give a simplified example of the type of situation with which the Netherlands was faced in 1950, let us assume that the analysis of the causes in the changes in the volume of money provides the following data for a certain period:

Government debt to banking system	+300
Private debt to banking system	+400
Net loss of foreign exchange	–1,000
Net change in monetary circulation	–300
Environmental conditions: a booming economy and rising prices

View Table

Government debt to banking system	+300
Private debt to banking system	+400
Net loss of foreign exchange	–1,000
Net change in monetary circulation	–300
Environmental conditions: a booming economy and rising prices

A customary explanation of this situation would be to say that the increased indebtedness of the government and the private sectors to the banking system indicates inflationary conditions in both sectors. One might feel surprised at the combination of these inflationary conditions with a drop in the volume of money, but would probably be satisfied by explaining this drop as the effect of the large balance of payments deficit to which one would be apt to attribute an autonomous character.

The picture completely changes, however, when, after splitting the economy into sectors and taking into consideration the movement of secondary liquidities, we find that the Government has been repaying its floating debt to the private sector to an amount of 500 units—half to institutional investors and half to the rest of the private sector—and that both institutional investors and the rest of the private sector have been spending these funds on long-term investment and on real expenditure, whilst they have also been running down their cash balances for the same purposes.

It then becomes clear that the inflationary impulse has originated completely in the private sector, that the Government in its own sphere even had a liquidity surplus, which was, however, strongly overbalanced by the inflationary financing in the private sector, this latter being fed not only from credit expansion but also from the liquid reserves in the hands of entrepreneurs, the public, and institutional investors.

Further considering the necessary increase in cash balances for transaction purposes, which must necessarily have been connected with the increase in national income resulting from boom conditions and price increases, we would rightly conclude that the drop in total cash balances in the hands of the private sector was actually giving only a feeble expression to the magnitude of the inflationary impulse exerted by the financing of new expenditure out of available cash reserves.

This example will show why the Nederlandsche Bank believes that its method of analysis, even though it cannot claim to give an exact quantitative measure of the monetary impulses that are at work, yet enables one to obtain a better insight into their origin, their character, and their approximate magnitude.

Use of the method in monetary policy

As a guide to monetary policy, it is particularly important to recognize clearly the origin of both actual and potential monetary disturbances. Minding the old adage that prevention is better than cure, it must be considered the prime task of monetary policy, where possible, to prevent disturbances from arising at all. Trying to compensate for disturbances that have once developed is only a poor substitute for prevention. And yet, we have to be alive to the fact that some of the possible monetary impulses are definitely beyond the control of monetary policy. In this connection I feel that the method of the Nederlandsche Bank has the advantage over other types of analysis of better bringing home to us the enormous importance of the volume of liquid claims in the hands of the public.

Monetary policy, by the use of discount policy and other techniques, can exert a relatively strong influence on the volume of money newly created to finance new expenditure. It can exert no influence, or very little influence, on the recourse of the public to available cash reserves in the form of ready cash. Neither, however, can it exert any important influence on the recourse the public has to its reserve of secondary liquidities, and the less so, the shorter the average maturity thereof. It is almost impossible for the central bank not to accommodate the debtors of the secondary liquidities if they are faced with nonrenewal. No increase in the rate of discount can force them to default on their obligations. And the possible indirect ways of compensating an inflationary impulse which originates from a recourse to secondary liquidities are difficult to find and still more difficult to carry out.

There is much talk by economists about the compensatory anticyclical budget policies that governments ought to pursue. There is, alas, in practical politics very little to show in this field, especially in periods of inflationary boom.

These conditions may indicate that the fight against inflation has to be fought much earlier than we usually think. Much more attention may have to be given to the building up of the inflationary potential during periods of all-over monetary equilibrium by the too easy creation of secondary liquidities.

In an open economy, these conditions also have their consequences for the desirable level of foreign exchange reserves. These must be sufficient to carry the load of any irrepressible spontaneous internal inflationary development, including the possible recourse to secondary liquid resources. One of the practical applications of the use of its method of analysis in the field of monetary policy is to be found in some arrangements that exist between the Nederlandsche Bank and the Netherlands Treasury. These arrangements are partly of a formal character and partly no more than a general understanding about some basic rules which the parties have accepted as a guidance for their policies.

Fundamentally, these arrangements are based upon the idea that indeed the liquidity surplus and the liquidity deficit of the Government, as defined by the Nederlandsche Bank, are proper measures of the deflationary or inflationary influence of government finance on the economy. As, generally, i.e., except under conditions of deflation, an inflationary influence of government finance should, of course, be avoided, the Treasury has on principle accepted the policy of not financing any expenditure by an increase of short-term debt, either in the hands of the banking system or in the hands of the public at large. On the other hand, the Nederlandsche Bank has recognized that the purpose for which the Treasury wishes to have recourse to the Bank is far more important than the fact that it should wish to do so at all. Consequently, the Bank has been willing on several occasions, e.g., in 1951, when the private sector of the economy fell back heavily on all available liquidities, to accommodate the Treasury by a direct purchase of treasury bills in order to enable it to repay short-term debt to the banks, but not to finance its own expenditure. Such recourse of the Treasury to the Bank has been called in the Bank’s Annual Report a noninflationary recourse.

Also, in the conduct of its open market policy, in as far as the latter is based on the portfolio of treasury paper which the Bank obtained when the Government took over from the Bank the wartime Reichsmark claim of 4½ billion guilders, the Bank has been willing to agree to certain restrictions on its liberty of action and even to a formal obligation to accommodate the Treasury under certain circumstances, both, however, under the condition that the Government should not indulge in any inflationary financing in the aforementioned sense. In that case the Bank has regained its full liberty of action.

These examples illustrate that the analytical method we are discussing has been not only of theoretical use, but also positively helpful in coming to a sound and fruitful working relationship between the central bank and the Treasury.

The fundamental rules on which this working relationship is based follow directly from the underlying principles of the method of analysis that have just been set out. They might be summarized as follows:

• (1) Borrowing by the Treasury from the central bank for the purpose of repaying debt to the banking system is by itself, i.e., apart from its indirect influence on bank liquidity, not of an inflationary character.

• (2) Borrowing by the Treasury from the central bank for the purpose of repaying short-term debt to the public is by itself not of an inflationary character if the public entrusts these funds to the banking system.

• (3) If, however, the public uses the released funds for financing new expenditure, such borrowing will indeed be indicative of an inflationary process. The origin of the inflationary impulse must then be attributed to the private sector of the economy.

• (4) Borrowing by the Treasury from the commercial banking system for the purpose of financing expenditure has, by itself, exactly the same inflationary character as borrowing from the central bank.

• (5) Borrowing by the Treasury from the public by issue of short-term debt for the purpose of financing expenditure can be actually, and is at least potentially, of an inflationary character. Such borrowing can fundamentally be justified only if serving to counteract the undesirable deflationary effects of spontaneous hoarding in the private sector of the economy.

Mr. Chairman, I am very grateful to you that you have taken the initiative for this panel discussion and that you have been so kind as to ask me to tell this illustrious gathering something about the methods the Nederlandsche Bank has been using to unravel the mystery of inflationary and deflationary developments. I do not claim that this method gives any final answer to the problem. I do believe, however, that it can be instrumental in attaining a better understanding of the strictly monetary aspects of the inflationary and deflationary process. Thus it may, perhaps, be helpful to both central banks and treasuries in better adapting their policies to fighting that curse of slow but persistent inflation that seems to be upon our present day world and to the lifting of which all our efforts should be dedicated.

Broad objectives

What impelled the Federal Reserve to launch this quantitative experiment? What have been, and continue to be, our intelligence goals? These are simple questions, but the answers are not simple.

The United States economy has had available for some years now a vast quantity of statistical data pertaining to its varied nonfinancial as well as financial activities. These data have been systematized and summarized in a variety of indices, in various aggregates, and in such relationships as the international balance of payments, the monetary reserve elements, the input-output accounts, and the national income-product accounts.

What has not been available is a sweeping organization of data that would demonstrate the primary fact that, in a market economy, the flow of credit and money affects all activities and, in turn, all activities affect the flow of credit and money. In other words, what has been lacking in the economy’s armory of information has been a single statistical panorama of both nonfinancial and financial activities—a record which would connect the money surface of things with the product surface. Such a pattern would furnish a moving picture image of the quantities that, in combination with market prices and interest rates, are generally subsumed under the term “the credit and monetary situation.”

Filling this need, we felt, would throw into new perspective the many problems which must concern any money management directed toward general stability of money purchasing power and orderly economic growth. It would help, for example, to clarify contemporary money functions by distinguishing more effectively between the store of value work, exchange of wealth work, and technical work that money and credit do. It would help further to delineate the role and functions of the various financial institutions.

In addition, it would tell which economic groups purchase the current national output as well as which groups purchase existing wealth and claims to wealth. It would show where the credit or money comes from to make both output and asset purchases, and would make understandable the changes which occur in cash balance and debt positions. And it would aid in tracing the flow of savings from surplus to deficit units, and would indicate the forms in which these savings flows occur.

Beyond this, it would reveal more plainly the relationships between current account payments and capital account payments, and would contribute to the assessment of debt positions, including the soundness of debt. It would illuminate the decision-making process, and help identify the sector source of impulses in economic expansion and contraction.

Lastly, it would assist in differentiating between instabilities caused by defects in financial organization and other instabilities resulting from psychological disturbances in single markets, which then pass through the entire economy, at times convulsively.

The objectives of the experiment, therefore, were broad, multipurpose, and fundamental. They were pursued with the main prepossession of wearers of the central banking cloth—namely, that monetary and other financial variables are vitally important determinants conditioning economic behavior and shaping economic events.

Some pragmatic considerations

The Federal Reserve staff sought a structure of data that would yield utmost flexibility of application to its own uses and to the uses of others. While monetary and financial research is a prime responsibility of a central banking system, it is also an activity of other government agencies, of universities, of financial and business institutions, and of independent scholars. A central bank, being at or close to the source of flow of much economic information, has a responsibility to make data available in well-ordered form for other users—in return for which it gets the benefit of their outside studies and criticism. Furthermore, the data supplied will make their greatest contribution if they are organized in advance with a view to general analysis rather than narrowly to monetary analysis.

In developing its flow-of-funds accounts, the Federal Reserve staff conscientiously endeavored to provide an accounting structure that would be as free as possible from ties to any doctrinaire approach or single theory of economic causation. The staff, moreover, was careful to avoid handicapping its own or any other analyst’s freedom to select hypotheses for testing, or freedom to combine or correlate data in testing. This necessarily has meant maintaining a neutrality toward economic concepts whose general definition accountingwise is moot because they are subject to special tailoring in accordance with the analytic objective or problem in hand. Savings, investment, money, and liquidity are specific examples of such concepts. Data in the flow-of-funds accounts can be combined in several ways to derive alternative measures of these concepts.

Critics may say that the Federal Reserve staff has been too purist in this effort to attain neutrality of accounting structure and data treatment. But this staff itself wants experimental latitude in defining and applying concepts, since the quest for improved or more effective quantitative norms for central banking must constantly be pressed forward in a spirit and atmosphere of unhampered research. Accounting definitions of economic concepts must freely adapt to the purpose or problem of inquiry; they cannot be permitted to express merely the hardened dictate of convention or previous official sanction.

Essence of accounts

The Federal Reserve staff is often asked to put in a nutshell just what the flow-of-funds accounts are. In simple terms, the accounts divide the nation’s economic decision makers into institutionally homogeneous groups, called sectors. For each sector, the accounts show transactions in goods, assets, and credit and money in a consistently defined system of classification. Thus, each sector account identifies and measures the main sources of funds with which the sector makes payments and its principal uses of funds in making payments.

The flow-of-funds accounts closely resemble the international balance of payments statement. In international studies, we have long recognized that understanding of a nation’s changing position in commerce with other nations requires the recording in a single statement of both goods, services, and gold flows, and credit and capital flows. The flow-of-funds accounts employ a comparable approach in domestic analysis.

For each institutionally distinct group within a nation, the flow-of-funds accounts provide related measures of the flows of goods and services and of credit and money. The accounts, in effect, provide a balance of payments statement for each major sector of the economy vis-à-vis the rest of the economy. The separate statements thus afford a framework for observing the changing positions of the major economic groups within the nation and the interaction of these changes with those for other sectors. The whole system of balance of payments accounts for the sector groups is simultaneously derived in accordance with standard accounting rules and hence is statistically integrated.

Relation to national income-product accounts

The following question is frequently asked about the flow-of-funds accounts: What is their relation to the national income-product accounts? And more specifically, what is contributed by the flow-of-funds accounts that is not already provided by the income-product accounts?

Brief contrast of accounting structures. A brief contrast between the two accounting structures can serve two purposes. In the first place, it can make plain that the systems are not substitutes or competitors. They supply different views of an economy’s aggregate activities. Both are needed for empiric inquiry. In the second place, a contrast can show why the accounting logic and sectoring of the two systems differ in so many respects.

The national income-product accounts are aptly described as economy performance accounts. They undertake to measure in both current and constant prices the final product available to satisfy current economic wants plus the final product utilized to provide the tools by which wants will be satisfied in the future. The product measured includes that exchanged by barter and that which is produced and consumed without passage through a market place.

The income-product accounts emphasize productive activity and the allocation of product among various types of use. Consequently, the sectors of the accounts represent types of activity—production, consumption, investment—rather than types of institutional unit. The income generated in the productive process is distributed by economic function or factor of production—worker or employee, proprietor, shareholder, or creditor.

Financial transactions, such as those in cash balances, securities, and other financial instruments, are excluded from the income-product accounts for two reasons, one strictly an accounting matter and the other a purposive matter. First, when all financial and nonfinancial transactions are consolidated into a single summary account for the total economy, borrowing and lending activities within the domestic economy must cancel out since they are necessarily equal. Accordingly, they are not recorded in the final summary accounts.

Second, measurement of the value of current product and income is an intelligence goal of prime importance in itself. Since the exchange of financial claims is not a component of the nation’s current product, many students have felt that the goal of measuring output and income should not be compromised by putting these exchanges into the accounting picture. There are some who would go further and argue that financial transactions are fundamentally of a lower order of importance for use in observing and analyzing economic realities.

The flow-of-funds accounts have quite a different focus. Their purpose is to describe in current money units the total flow through markets of transactions in current product, existing assets, and financial claims. In their present form, they exclude as far as practicable barter transactions, imputed transactions, and bookkeeping transfers among the internal accounts of single transactors, such as capital consumption allowances. The accounts show only cash and credit transactions.

The accounts are focused on the main work that credit and money do in clearing markets and on the structure of financial assets and debts remaining after such clearance. Actions in these markets are by decision-making units responding to forces growing out of a variety of past commitments and a variety of current incentives for spending or investment. Hence, the economic unit of accounting must be the individual or institution that makes decisions. Furthermore, the transaction record of the accounts must include current and capital transactions and, as a minimum, changes in financial assets and liabilities.

Thus, the sectoring or allocation of transactions is on an institutional rather than an activity basis. Financial institutions, divided into as many subgroups as are deemed appropriate, are an essential feature of the account sectoring. The transactions classification is pragmatic, that is to say, transactions are grouped into categories that appear to be meaningful in terms of market processes.

The user of the flow-of-funds accounts is obliged to recognize that activity in markets is the outcome of decisions by many different individuals and institutions acting as economic units. The behavior of each unit must be observed through all of the transactions in which it may engage. For summary observation, their total behavior must be analyzed in the same manner. Stated another way, the meaning of a given group’s cash balance, liquidity, debt, or savings and investment position, however defined, cannot be adequately analyzed without reference to the group’s total receipts and expenditures, their composition, and other associated financing as reflected in asset and liability changes. Similarly, nonfinancial transactions must be studied in relation to each group’s financial position and activities. This is general equilibrium analysis in empiric form, and central banking must engage in such analysis to achieve its key intelligence need—a balanced objective view of the entire credit and monetary situation.

Examples of contrasting accounting treatment. The differences between national income-product accounts and the flow-of-funds accounts may be further clarified by a few examples of contrasting treatment.

The income-product accounts, for instance, record in separate activity accounts transactions for current consumption and transactions ordinarily thought of as investment in tangible assets. Thus, consumers’ purchases of homes are taken into the same account as landlords’ purchases of rental housing and business purchases of new plant and equipment. But in the flow-of-funds accounts these several transactions are recorded in at least three sectors: the consumer sector, the unincorporated business sector, and the corporate business sector.

The reasoning behind this institutional sectoring is to be found in the main purposes of the accounts, namely, to understand the interplay and interaction of market transactions by major groups of decision-making units. The purchase, say, of a home by a consumer household is influenced by factors recorded in the accounts, such as the amounts spent for current living, the receipts margin over current living, the cash and other financial balances previously set aside and on hand, and the amount of debt and debt service for which obligations have already been assumed. The home purchase decision is also influenced by factors external to the accounts, such as the cost and availability of home mortgage credit and the home purchase price. The market process for home purchases, or any other market process for that matter, may not be realistically summarized or seen empirically except in these terms.

There are other aspects of home ownership that bring out the difference in accounting rule applicable to the two systems of accounts. In the income-product accounts, the costs of home maintenance are recorded as an expenditure of the business sector; an imputed rental payment is recorded in personal consumption expenditures; and the excess of this imputed rental over costs of maintenance and depreciation is recorded in the personal income account. Since financial flows are excluded from the accounts, neither the incurrence of a mortgage nor the repayment of mortgage debt would be recorded anywhere. In the flow-of-funds accounts, imputed rents are excluded from the entries, but actual payments on home maintenance and debt service, as well as the net change in mortgage debt, are entered in the consumer sector account along with all other receipts and payments.

Another illustration of contrast between the two systems of accounts is in the treatment of unincorporated business establishments. The logic of the income-product accounts does not require a separate treatment of these units in special sectors. In the flow-of-funds accounts, a distinction between unincorporated and incorporated business is adhered to on institutional grounds, because the legal form of organization affects financial patterns of business and access to financial markets. And the financial patterns and decision making of the farm business are unique to that activity, so that incorporated and unincorporated farms are grouped together in a special farm business sector.

A final difference to be mentioned is one already underscored—the income-product accounts have no sector for financial institutions, whereas the flow-of-funds accounts have several such sectors. The flow-of-funds accounts are designed to throw light on financial as well as nonfinancial transactions. Since financial transactions are the primary function of financial institutions, their separate sectoring and subsectoring must be provided for to express this broader perspective.

An illustrative application, 1953–55

The Federal Reserve flow-of-funds accounts for the United States were first published in December 1955. Their wealth of detail has overwhelmed not a few consumers of statistical information. These consumers have asked: Can this rich quantitative record be put to work? Or is it mainly useful as a directory of statistical numbers—a sort of telephone directory?

Getting data organized and ready for analysis and applying them in analysis are successive steps in a research process. The accounts, as emphasized earlier, are constructed with general purpose objectives. Also, as emphasized earlier, application to many analytical problems thus far has been handicapped by the unavailability of the accounts on a quarterly basis. But some progress in this direction has been made. Using the preliminary quarterly data at hand, we will apply the accounts to a special purpose—a picturing of the credit and monetary situation in the United States over the years 1953–55, an interval marked by recession and recovery.

The illustration must necessarily be condensed and incomplete. A full explanation of the combinations of data employed must be reserved for footnotes to the charts presented, but every effort has been made to identify the curves in a self-explanatory way. One point of simplification may be mentioned in advance. The terms “credit” and “credit markets” are used to cover transactions in both debt and equity instruments.

Chart 1 portrays the total amount of funds—both debt and equity—raised in United States credit markets in each quarter of this three-year period. Note, first, the clear upward drift of financing demands, so that financing activity in the recovery months of 1955 moved above levels reached in the peak period of the preceding cycle. Note, secondly, the wide seasonal swing in financing activity. These wide movements highlight one of the principal, but little commented on, tasks of central banking operations, namely, that of moderating the market impact of fluctuations in credit demand within the year, caused by the seasonal swings in financing needs of consumers, business, agriculture, and government. They also suggest the complexities of the credit market problem when a cyclical upsurge in financing demand coincides with a peak in seasonal financing demand.

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Funds Raised in Markets

(In billions of U.S. dollars)

Citation: IMF Staff Papers 1957, 001; 10.5089/9781451960211.024.A001

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In Chart 2, total funds advanced during the years covered are shown, together with a subdivision of the total into commercial banking and other sources. Here, the savings and time deposits of commercial banks are grouped with other sources. The picture emphasizes the role that commercial bank activity plays in absorbing seasonal increases and decreases in financing demand. It also brings out the increasing importance during the 1954–55 recovery period of sources of funds other than commercial banking.

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Funds Advanced In Markets

(In billions of U.S. dollars)

Citation: IMF Staff Papers 1957, 001; 10.5089/9781451960211.024.A001

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We must now look behind these totals to see what groups were taking and what groups were supplying funds. Chart 3 shows that the most volatile part of the demand for financing stems from the Federal Government. Seasonal swings in financing demands are dominated by those of the Federal Government. Behind this wide seasonal movement is the heavy concentration of personal and corporate income tax receipts in the first half of the year. One point of interest before leaving this chart is the gradual dampening of Federal Government financing demands over this short period. Government expenditures were cut in the early part of the period, and tax and other receipts rose in the latter part. Thus, as upswing in activity progressed, fiscal policy played an increasing countercyclical role.

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Funds Raised, by Sector

(In billions of U.S. dollars)

Citation: IMF Staff Papers 1957, 001; 10.5089/9781451960211.024.A001

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Chart 3 also brings out that consumer and business demands for financing were of about the same order of magnitude over this period, a fact no doubt surprising to many. Also, these two sources of demand accounted for most of the slackening of total demand in the 1953–54 recession and all of the increase in total demand which occurred during the recovery phase. The volume of funds raised by other sectors, mainly state and local governments, showed more seasonal and cyclical stability over the entire period. The volatility shown by consumer financing merits further attention.

The changing financial position of consumers during the period is traced on Chart 4, which shows the consumers’ surplus of funds on current account, their outlays for purchasing new homes and durable goods, the total of their funds advanced or lent to other sectors, and their borrowing. On the whole, consumer capital outlays were well maintained during the 1953–54 recession, with financing from their own funds displacing borrowing to an appreciable extent in one phase of the downdrift. Consumer capital outlays expanded sharply in the fourth quarter of 1954, and remained high during 1955. In this period, the difference between the current surplus and capital outlays narrowed markedly. The accompanying pressures on consumer resources are evidenced by the narrowing margin between funds advanced and funds borrowed.

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Consumer Sector: Sources and Uses of Funds

(In billions of U.S. dollars)

Citation: IMF Staff Papers 1957, 001; 10.5089/9781451960211.024.A001

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Consumer borrowing is mainly for the purpose of financing capital outlays, so that a tolerably close correspondence in movement might be expected in the consumer capital outlay curve and the consumer borrowing curve. The dissimilarity in movement of the curves is, therefore, rather striking. However, if one adds to capital outlays the purchases of used durable goods and used houses, as in Chart 5, the pattern of movement of the two series becomes somewhat closer.

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Gross Capital Outlays: Consumer Sector

(In billions of U.S. dollars)

Citation: IMF Staff Papers 1957, 001; 10.5089/9781451960211.024.A001

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To show the shifting pattern of business finance, Chart 6 presents a condensed flow-of-funds picture for all business combined. The surplus on current account of the business sectors, calculated here after income tax payments, naturally shows sharp seasonal swings because of the tax payment schedule. Similar seasonal swings are shown in business funds advanced to other sectors, principally because business accumulates securities to provide for tax payments and then liquidates the securities to pay taxes.

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Business Sectors: Sources and Uses of Funds

(In billions of U.S. dollars)

Citation: IMF Staff Papers 1957, 001; 10.5089/9781451960211.024.A001

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Capital outlays and borrowing are of particular interest in Chart 6. Business capital outlays declined irregularly over the recession quarters and increased in 1955 but not to levels much above those of the preceding cyclical peak. As capital outlays decreased, borrowing first moved up and then went down. As an uptrend in capital outlays followed through 1955, borrowing rose. In the last quarter of 1955, business borrowing increased sharply, accompanying a bulge not in capital outlays but in funds advanced. This bulge in funds advanced reflected in part provision for taxes at rising levels of earnings, in part larger financing by the business sector of consumer capital outlays, and in part intrasector extension of trade credit.

So much for the demand side of the financing picture over the 1953–55 period. Let us look more closely into the supply side. Measures of the funds advanced directly to the credit markets are presented in Chart 7. The amounts traced are the net lending by major sectors through the debt and equity instruments issued by nonfinancial sectors. Wide seasonal swings are shown for the funds supplied by business and by commercial banks, and an upward trend marks the business lending curve. The volume of funds supplied by financial intermediaries—savings banks, insurance companies, savings and loan associations, credit unions, investment trusts, and pension funds—remained remarkably constant over the period. Funds supplied by consumers decreased from mid-1953 to the third quarter of 1954, and then, with business recovery in 1955, rose to about the level of the preceding cyclical high.

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Funds Advanced in Markets, by Sector

(In billions of U.S. dollars)

Citation: IMF Staff Papers 1957, 001; 10.5089/9781451960211.024.A001

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As Chart 8 shows, the direct advance of funds to the credit and capital markets is not the only supply contribution made by consumers. They also contribute indirectly by adding to cash balances and by channeling funds through financial intermediaries through deposits and shares in savings institutions and net premium payments to life insurance companies. Their advances to intermediaries were relatively stable, but their holdings of cash showed considerable variation, declining during the first phase of recession and increasing appreciably during the late phase of recession and early phase of recovery. After decreasing as recovery gained full swing, consumers’ cash balances showed little change in 1955. Many of these changes in consumers’ cash balances were inverse to the changes in their holdings of government securities.

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Consumer Sector: Funds Advanced

(In billions of U.S. dollars)

Citation: IMF Staff Papers 1957, 001; 10.5089/9781451960211.024.A001

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For business, in contrast, as Chart 9 illustrates, direct advances and changes in holdings of cash have moved together over this period. Beginning in mid-1954, however, business held more of its liquidity in securities, notably short-term government securities, than in cash—a development related to the rise in market interest rates accompanying the recovery movement.

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Business Sectors: Funds Advanced

(In billions of U.S. dollars)

Citation: IMF Staff Papers 1957, 001; 10.5089/9781451960211.024.A001

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The changing composition of funds advanced by all nonfinancial sectors together is pictured in Chart 10. Through this cycle in demands for financing, the flow of funds made available to nonbank financial intermediaries was remarkably stable. Response to both seasonal and cyclical fluctuations in demand for funds was primarily through changes in direct lending among nonfinancial sectors and in their cash balances. The heavy demand for funds which developed as spending activity increased in late 1954 and in 1955 was met to a large extent by direct lending on the part of the nonfinancial sectors and by more active use of cash balances.

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Nonfinancial Sectors: Funds Advanced

(In billions of U.S. dollars)

Citation: IMF Staff Papers 1957, 001; 10.5089/9781451960211.024.A001

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These charts have shown the wide quarterly fluctuations in borrowing and lending activities. The concluding chart, Chart 11, puts the quarterly flows of debt instruments in the perspective of the total of public and private debt outstanding. The main point to be observed is that consumer debt showed the most rapid rate of growth in this period. The debt of state and local governments also grew steadily and rapidly. Business debt rose more slowly through most of the period, but the rate of increase accelerated in the second half of 1955. The stability of federal debt over this period kept the rise in financing demands from other sectors from pressing unduly against the available supply of savings.

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Total Debt, by Sector

(In billions of U.S. dollars; logarithmic vertical scale)

Citation: IMF Staff Papers 1957, 001; 10.5089/9781451960211.024.A001

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This all too sketchy image of the shifting credit and monetary situation over an important fragment of recent history illustrates alternative responses that each of the major groups can make to changing pressures in financial markets and in their own financial positions. It is this diversity of response pattern that makes research for policy purposes complex and makes risky any generalization on merely a few elements in the economy.

At the outset, we stated that the single objective of this graphic presentation was to offer an experimental example of the analytic utility of the flow-of-funds accounts. If the combinations of data shown in the charts have been suggestive, they will have served their purpose.

Concluding observations

The need to construct a statistical bridge between the money surface of things and the product surface is one felt by economic observers in other countries as well as in the United States. Some have undertaken to meet the need by resectoring the income-product accounts and by adding, to the derived transactions record, measurements by sectors of exchanges of existing assets, transfers of claims to wealth, and changes in debtor-creditor positions. These undertakings have obviously been in the same direction as, and have a close family relationship to, the Federal Reserve flow-of-funds accounts.

The difference between them and the flow-of-funds accounts is partly a matter of approach and partly a difference in scale of experiment. Our own experimental drives led us to undertake a comprehensive rearrangement, reallocation, and supplementation of the income-product accounts so that a panoramic view of market processes within a single accounting framework could be achieved. This departure from the limitations of existing accounting structures represents, in fact, a central contribution of the flow-of-funds accounts. Admittedly, some qualified observers will say that the strangeness and complexity of the new accounting structure is too high a price to pay for this contribution.

Any rearrangement of data to achieve a general observational view involves difficult, at times delicately balanced, choices as to the stratification of data. The choices made by the Federal Reserve staff are at many points tentative and open to dispute. We do not urge these choices upon other statistical workers as the only reasonable solutions. But statistical workers in other countries should be urged to bridge the statistical record of the money surface of things and the product surface. Such a bridging obviously has to be done with a special eye to the distinctive institutional features of a particular economy. And it must be accomplished within the limitations of available data.

We can all learn much from one another’s experimental endeavors along these lines. But at this stage of intelligence, progress in the national accounting arts can be severely handicapped by standardizing the measurement of payments too quickly with a view to international comparability. It is not so important that we observe relations within the different economies on the basis of a uniform accounting pattern. But it is important that new analytic tools are developed which are effective in serving the vital need, recognized in all countries, of bridging the gap between money activities and product activities so that monetary and other stabilization policies are determined with as much public understanding as possible.

Notes to charts

The time series presented in these charts are special groupings of quarterly flow-of-funds data, and the following notes describe the groupings in terms of flow-of-funds sectors and transaction categories. The sectors and transaction categories themselves are explained in detail in Flow of Funds in the United States, 1989–68 (Board of Governors of the Federal Reserve System, 1955).

A general point to be made here is that the term “net change” in financial assets and liabilities in these notes refers to net flow—the excess of asset purchases or of borrowing over receipts from sale of assets or from retirement of debt. Capital gains and losses from changes in valuation of assets and liabilities are not included in either the data or the term “net change” as used here. It should also be stated that, for convenience of statement in the notes, the words “liability,” “claim,” and “borrowing” cover equity shares in corporations as well as debt instruments.

Liquidity analyses—money and banking statistics

Money and banking statistics are the first source of Monetary Analyses. The money and banking system clearly plays a unique role in finance, not only because its financing transactions are large compared with the total of all intersector financing transactions, but also because the wide acceptability of its liabilities enables it to finance sector deficits that would not be financed directly by the other sectors. The accounts of the money and banking system are therefore the source of statistics on the supply of liquid assets and the source of statistics of a very important sector in intersector finance.

Monetary Analyses have been made from the accounts of the money and banking system in a large number of countries and in a number of different ways. Some analyses undertake to account for the liquidity-creating potential of the system; others undertake to account for the liquidity creations of the system. The first are analyses of actual or potential bank reserves; the second are analyses of money or of money and its close substitutes.

Extended money and banking statistics

The extension of money and banking type statistics to cover the whole of the financial institutions sector and also the accounts of other sectors whose data are relatively easily available has provided a second source of Monetary Analyses. While the accounts of the money and banking system cover a large part of all borrowing and lending, any extension of the analysis to include the accounts of other sectors increases the possibility of deriving useful indications of the accounts of the remaining sectors. The sectors whose accounts are relatively easily available are the other financial institutions sector (i.e., financial institutions other than the money and banking system), the government sector, and the foreign sector.

Matrices of intersector finance

The process of “horizontal” expansion of money and banking statistics—through the inclusion in money and banking type analyses of the accounts of all financial institutions, the financing accounts of the government, and data from the balance of payments—has led to the construction of financial statistics of very much the same type as those now being developed in a few countries through a “vertical” expansion of national income statistics. The compilation of national income statistics with income, expenditure, investment, and savings accounts for each of the sectors raises the question of accounting for the means by which sector deficits and surpluses are financed, and suggests the addition to national income accounts of intersector borrowing and lending statistics. The national income statement may be considered as the “top half” of a full statement of an economy’s transactions. The financial accounts may be considered as the “bottom half.” Data compiled as an extension of national income accounts may therefore be considered as the third source of Monetary Analyses.

Matrices of intersector finance constructed as vertical extensions of the national income accounts or in answer to the questions raised by the national income accounts are a recent addition to statistics. Data are available for France in the Ministry of Finance report, Accounts of the Nation; for the Netherlands, in the Central Planning Bureau’s Central Economic Plan; and two statements for Germany, in the Monthly Report of the Bank deutscher Lander and in the Quarterly Bulletin of the German Institute for Economic Research. The United Kingdom, in National Income and Expenditure, has taken some preliminary steps toward the compilation of financial data related to the national income accounts. In the United States, the flow-of-funds accounts of the Board of Governors of the Federal Reserve System have been compiled to account consistently for all financial and nonfinancial transactions in a single accounting system designed for that purpose. The Canadians are working on a slightly different system of flow-of-funds accounts.

The construction of intersector financing accounts consistent with the national income accounts raises problems, since there are several points at which the definitions that are useful in the measurement of income and consumption are not useful in the measurement of borrowing and lending. The “bottoms” do not easily fit the “tops” and a bridge is required. There are two principal problems.