Credit Aggregates from the Flow of Funds Accounts

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One reason analysts study financial variables is to determine how activity in financial markets affects the macroeconomy. For example, there is evidence that reduced credit flows contributed to the Depression (Bernanke 1983). Likewise, the Federal Reserve's Credit Restraint Program of 1980 magnified the 1980 recession by increasing uncertainty about credit availability (Schreft 1990). More recently, analysts have debated the implications of rapid credit growth for financial stability (Federal Reserve Bank of Kansas City 1986) and argued that debt repayment by consumers and businesses contributed significantly to the 1990-91 recession and the unusually weak recovery that followed (1992 Economic Report of the President, p. 27). The link between financial intermediation and economic growth and development is an ongoing area of study (e.g., McKinnon 1973; Greenwood and Smith 1993).

Analysts use both broad and narrow measures of credit in macroeconomic research. Support for using broad measures of credit comes from the ease with which different forms of credit substitute for one another. Because of this substitutability, broad measures reflect more accurately, for example, the extent to which credit availability is reduced during a credit crunch. Moreover, broad measures complement the monetary aggregates. In fact, since 1983, the Federal Open Market Committee, the Federal Reserve System's monetary policymaking arm, has set monitoring ranges for domestic nonfinancial debt.

In contrast, narrow measures focus only on specific types of credit. Some researchers focus on bank credit. for example, because they argue that it plays a crucial role in the mechanism by which monetary policy is transmitted to the real economy (see Morgan [1992] for a summary of this position). These researchers justify the use of the narrow measure by arguing that for some borrowers bank credit is the only form of credit available to finance spending plans; substitutability of bank and nonbank credit is not possible for these borrowers.

The leading source of data on credit aggregates is the Flow of Funds Accounts (FOFA). This article provides an introduction to the accounts. The first section describes the nature, history, and availability of the accounts. Section 2 explains the accounts' organization by sector and transaction. The third section traces the behavior over time of various credit measures from the FOFA. Section 4 highlights features of the accounts that warrant caution, and finally Section 5 provides suggestions for additional readings that provide a more thorough discussion of the accounts.

1. AN INTRODUCTION TO THE FLOW OF FUNDS

Nature of the Accounts

The FOFA are designed to measure the financial and nonfinancial transactions associated with sectoral and aggregate investment activity. By cataloging the financial flows associated with current income and production, the FOFA complement the National Income and Product Accounts (NIPA). While the NIPA measure total saving and investment in a particular sector, the FOFA reveal how a sector finances investment in excess of its saving. That is, according to economist James Tobin (1962, p. 190), the FOFA are an

ex post record of the processes by which supplies and demands for various financial assets are balanced....The basic behavior behind the flow of funds is the adjustment of the balance sheets, or portfolios, of individuals, business firms, and financial enterprises toward a desired allocation of wealth among holdings of various assets and debts. In this adjustment, the basic decision variables are stocks; and flows will be dominated by attempts to adjust stocks to changes in total wealth, interest rates, and other determinants.

The information in the FOFA is potentially of great use to economists, policymakers, and financial market participants. Surprisingly, however, knowledge and use of these accounts for economic analysis has been limited. …