4. The National Income and Product Accounts and the Flow of Funds Accounts 4.1 National Income and Product Accounts 4.2 The Flow of Funds Accounts The National Income and Product Accounts (NIPA) and the Flow of Funds Accounts (FFA) are more than just the places where much macroeconomic data come from. They help us organize our thoughts about the structure of the economy, and they provide the framework for constructing models of the economy. The exercises in this chapter are designed to get you acquainted with the two sets of accounts. 4.1 National Income and Product Accounts 4.1.1 DefinitionsBy definition, GDP is equal to consumption plus investment plus government spending plus exports minus imports. In the US model there are six sectors and a number of categories of consumption, investment, and government spending, which make the GDP definition and other definitions somewhat more involved. It will be useful to begin with the definition of total sales of the firm sector, denoted X, which is defined in equation 60. Equation 60 is: 60. X= CS + CN + CD + IHH + IKF + EX - IM + COG + COS + IKH + IKB + IKG + IHF + IHB - PIEB - CCB Experiment 4.1: The Components of X Table variable X and its components (from equation 60) for 2011:2. Note that some components are quite small. You should use this experiment to get a feel for the size of the various components. Note what a large fraction consumption is of total sales. By definition production minus sales is the change in inventories. This definition is equation 63: 63. V = V-1 + Y - X where V is the stock of inventories at the end of the quarter, Y is production, and X is sales. Also, by definition, the change in inventories is inventory investment, which is equation 117: 117. IVF = V - V-1 where IVF is inventory investment of the firm sector. In the model Y is determined by equation 11, which reflects production smoothing behavior, X is determined by the identity 60, V is determined by the identity 63, and IVF is determined by the identity 117. Y is not total GDP; it is only the part of GDP produced by the firm sector. Some production also takes place in the financial and government sectors. Equation 83 defines real GDP as production in the firm, financial, and government sectors: 83. GDPR = Y + PIEB + CCB + PSI13*(JG*HG + JM*HM + JS*HS) + STATP where PIEB + CCB is production in the financial sector and the term after that is production in the government sector. STATP is a statistical discrepancy pertaining to the use of the chain weighted data, which is discussed in Fair (1994). Experiment 4.2: Going from X to GDPR Table X, Y, IVF, and GDPR for 2011:2. Note that IVF is small relative to Y and that most of GDPR is Y (i.e., most of GDPR is produced by the firm sector). 4.1.2 Nominal versus Real GDP As any introductory economics textbook discusses, it is important to distinguish between nominal and real GDP. By definition, nominal GDP is equal to real GDP times the GDP price index. In the model, this relationship is equation 84, which is used to determine the GDP price index: 84. GDPD = GDP/GDPR Use the tables and graphs of GDP, GDPR, and GDPD from the previous chapter to examine the relationship between GDP and GDPR, i.e., to examine GDPD. During which periods would it have been particularly misleading to have focused on GDP instead of GDPR as a measure of output? 4.1.3 Federal Government Variables The NIPA are useful for examining the role that the government plays in the economy. Total expenditures of the federal government (EXPG) are defined in equation 106, and total receipts (RECG) are defined in equation 105: 106. EXPG = PUG + TRGH + TRGR + TRGS + INTG + SUBG - WLDG - IGZ 105. RECG = TPG + TCG + IBTG + SIG The federal government surplus (+) or deficit (-) (SGP) is the difference between receipts and expenditures, which is defined in equation 107: 107. SGP = RECG - EXPG Experiment 4.3: The Federal Government Budget Table the variables in equations 105, 106, and 107 for 2011:2. What are the largest components of government expenditures? What are the largest sources of government receipts? 4.2 The Flow of Funds Accounts We now turn to some equations that relate to the Flow of Funds Accounts. There are six sectors in the model, and there is an equation that defines the financial saving of each sector. The financial saving of the household sector (SH), for example, is defined in equation 65: 65. SH = YT + CCH - PCS*CS - PCN*CN - PCD*CD - PIH*IHH - PIK*IKH - TRHR - THG - SIHG + TRGH - THS - SIHS + TRSH + UB + INS - WLDF The financial saving of a sector is all the receipts of the sector minus all of its expenditures. If receipts are greater than expenditures, there is positive saving; otherwise the sector is running a deficit. There is also an equation for each sector that defines its budget constraint. If, for example, a sector's financial saving is positive, this must result in an increase in at least one of its assets or a decrease in at least one of its liabilities. The budget constraint of the household sector is equation 66 (remember that <> means "change in"): 66. 0 = SH - <>AH - <>MH + CG - DISH AH is the household sector's net financial assets except for its holding of demand deposits and currency (MH). CG is the capital gains variable, and DISH is a discrepancy term. If CG is positive, then AH increases because corporate stocks held by the household sector are included in AH. Taking CG as given, equation 66 shows that if SH is positive and MH is unchanged, then AH must increase. In other words, a positive level of saving must result in an increase in net financial assets unless it all goes into demand deposits and currency. The same considerations apply to the other sectors of the model. The five other saving equations are 69 (firm sector), 72 (financial sector), 74 (foreign sector), 76 (federal government sector), and 78 (state and local government sector). Note that federal government saving (SG) is almost always negative because the federal government almost always runs a deficit. (The federal government surplus or deficit variable in the model is actually SGP, not SG, but for all intents and purposes SG and SGP are the same. There are minor accounting differences between the two variables.) Note also that the saving of the foreign sector (SR) is the negative of the U.S. balance of payments on current account. The five other budget constraint equations are 70 (firm sector), 73 (financial sector), 75 (foreign sector), 77 (federal government sector), and 79 (state and local government sector). Equation 77, the federal government budget constraint, was discussed in Section 2.5. An important constraint in the FFA is that the sum of the financial saving across sectors is zero. Someone's expenditure is someone else's receipt, which is what this constraint says. In the notation in the model the constraint is: 0 = SH + SF + SB + SG + SS + SR If you combine this equation with the six budget constraints, you get equation 80 in the model: 80 0 = <>AH + <>AF + <>AB + <>AG + <>AS + <>AR - CG + DISH + DISF + DISB + DISG + DISS + DISR + STAT + WLDF - WLDG - WLDS - DISBA Equation 80 is another way of saying that the sum of the saving across sectors is zero, in this case using the net financial asset variables rather than the saving variables. Because of the budget constraints, these two ways are equivalent. Equation 80 is redundant in the model because it is implied by the six budget constraints plus the fact that the saving variables sum to zero. It is, of course, a good way of checking that the data are correct. Experiment 4.4: Saving Equations and Budget Constraints Table the variables in equations 65 and 66 for 2011:1 and 2011:2. Do the same for the variables in equations 69 and 70, in equations 72 and 73, in equations 74 and 75, in equations 76 and 77, and in equations 78 and 79. Note that the budget constraints are met in the data aside from rounding errors. (Remember when you check the budget constraints, you must multiply the computed changes in the stock variables by four, since the saving variables are at annual rates. See the discussion in Section 2.6. The changes in this case are 2011:2 values minus 2011:1 values.) Observe that the six saving variables, SH, SF, SB, SG, SS, and SR, sum to zero. Who are the big savers and who are the big dissavers? Check equation 77 carefully, and review the discussion of this equation in Section 2.5. Check the budget constraint for the foreign sector carefully. Why has AR been increasing so rapidly recently? The final constraint that will be discussed is the demand deposit identity, equation 71: 71. 0 = <>MB + <>MH + <>MF + <>MR + <>MG + <>MS - <>CUR MH, MF, MR, MG, and MS are demand deposit and currency holdings of the various sectors. CUR is the amount of currency in the hands of the public. MB is the total amount of demand deposits held; it is negative because demand deposits are a liability of banks. Experiment 4.5: The Demand Deposit Identity Table the variables in equation 71 for 2011:1 and 2011:2. Check that equation 71 is met for 2011:2. Which sector holds the largest amount of demand deposits and currency? Which sector holds the smallest?