What are Flow of Funds Indicators?
The flow of funds indicators are metrics used by governments to track the flow of money to and from the national economy. The accounts show the sources of all funds received in the economy and the uses they have been put to in the economy.
The national government, investors, and financial managers monitor the flow of funds to determine how effectively they have planned, what are the types of resources at their disposal, how the resources have been invested, and what are the sources used to finance the resources.
Flow of Funds Accounts in the US
In the United States, the flow of funds accounts are maintained by the Federal Reserve, and they are released about ten weeks after the end of the previous quarter. The flow of funds accounts are also known as financial accounts, and they are labeled as Z.1. The released accounts show the assets and liabilities that each sector of the national economy has contributed and how the funds have been used.
The statement for each account shows the distribution of capital across the various sectors, and this enables economists to analyze how funds flow in and out of the economy. The accounts also break down the total debt by issuer and holder, as well as the distribution of the Gross Domestic Product (GDP).
When preparing the flow of funds accounts, the Federal Reserve follows the double-entry bookkeeping method. This enables the tracking of changes in assets and liabilities in the non-financial sectors such as households, non-profit organizations, farms, the government (federal, state, and local), as well as in the foreign sector.
Some of the financial assets that are accounted for in the flow of funds include saving deposits, treasury assets, pension funds, mutual fund shares, American deposits abroad, corporate equities, and money market funds.
Flow of Funds in the UK
The Office for National Statistics is responsible for preparing the flow of funds accounts in the United Kingdom. The accounts present information on debtor and creditor relationships, and on how the assets and liabilities have changed in the national economy. According to the ONS, every financial asset should have a counterpart liability transaction, while the total sources of funds must be equal to the total uses of the funds.
The first flow of funds tables were published in 2014, and since then, they are published every quarter of the year in the Blue Book. The flow of funds account is based on the principle that all movements of funds in the economy must be accounted for by the relevant government entity.
The sectors that are accounted for in the UK flow of funds account include the central government, local governments, households, monetary financial institutions, public corporations, private non-financial corporations, and insurance corporations.
In addition, the financial instruments that are considered in calculating the accounts include debt securities, short-term and long-term loans, financial derivatives, employee stock options, equity and investment fund shares, and currency and transferable deposits.
How to Measure Flow of Funds
There are several indicators that investors can consider when determining the flow of money in the economy:
1. Mutual fund cash levels
Investors can look at mutual fund levels to determine how much money institutional investors have to buy stocks. When the mutual fund levels are low, it shows that the institutional funds do not have a lot of cash that they can use to invest in new stocks. Any kind of reallocation will require the institution to dispose of some of the assets that it already owns.
Where the institution has high mutual fund levels, it shows that it has enough ready capital that it can use to purchase stocks. Mutual funds cash levels are only a reliable fund flow indicator short term, and may provide misleading data if used in the long term.
2. Marginal debt
Marginal debt is another indicator of the movement of money in and out of the economy. When bull markets are overbought, investors tend to invest everything they have in the market with the hope of reaping substantial benefits from the favorable market environment.
Such investor behavior occurs when margin debt levels are at their highest since investors have the option of using a cash account to cover the whole investment or using a margin account (meaning that they borrow part or all of the capital they commit to an investment).
A margin account is offered by a brokerage to facilitate the purchase of a security by an investor. When large amounts of margin debt have been deployed for the purchase of securities, it confirms that there is a large movement of money in the national economy.
Uses of Flow of Funds Indicators
1. Performance indicator
Governments use the flow of funds indicator as an economy-wide performance indicator. Comparing the current year’s data and the data from the previous years can show the strength of the economy and the trend from previous years. It may also show the direction of the economy in the future, and the specific sectors that will lead to its growth.
2. Formulation of monetary policy
The government can use the flow of funds data to formulate monetary and fiscal policy. After the implementation of the policies, the government can use the indicators to determine if the policies bring economic stability or fluctuations and to find ways to address their negative impact.
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