The fine art of reading financial accounts and balance sheets

Peter van de Ven, OECD Statistics and Data Directorate

©REUTERS/John Gress

Worried what the future holds in store for the world economy? Picking through national accounts data can improve your understanding.

It’s 2018 and that means a decade has passed since the collapse of financial markets that led to the onslaught of the worst economic and social crisis in our lifetimes. And we are not out of the woods yet! Indeed we are still grappling with the consequences of the crisis today. True, the economy as measured by GDP and employment have returned to their pre-crisis levels in many countries, but unorthodox monetary policies remain in place, such as expanding the money supply through “quantitative easing” and low or even negative interest rates. Some experts worry that we may be entering into a new era of asset price bubbles. Central bankers are pulling their hair out trying to figure out how to reverse these policies without disrupting capital markets and the economy at large. Rapid credit expansion is happening in emerging market economies, which may exacerbate financial vulnerabilities worldwide, while high public debt levels in developed countries could cramp governments’ ability to act if there is another financial crisis, as it has in the past.

Trying to understand all these phenomena underlines how useful and important it is to be able to reach for timely, reliable and comprehensive data to help you monitor financial and economic developments, and their interconnections across sectors and countries. The framework of financial accounts and balance sheets (part of the system of national accounts) is the mechanism that delivers essential macro-economic information to help assess financial risks and vulnerabilities, and analyse links between the world of finance and the “real” economy, key elements that policymakers need to make informed decisions.

However, policy analysts and researchers often overlook this rich source of information, and underestimate the useful role such accounts play in the pyramid of official statistics.

Financial accounts and balance sheets basically provide a complete and consistent overview of the assets and liabilities of sectors such as households, non-financial corporations, financial corporations, and government, as well as the financial relations of a country with the rest of the world. You can derive, for example, how much national governments and households are indebted, according to narrower and broader definitions. The financial accounts and balance sheets not only provide information on the stocks of financial assets and liabilities, but show how savings are used to invest or how investments are financed by incurring liabilities, and how stocks are affected by holding gains and losses. They show, for example, how investments by corporations are financed by retained profits or by additional borrowing. Or whether holding gains on assets accumulated by pension funds help to sustain the payments of future pension benefits.

The macro-economic framework brings coherence to hundreds of statistical sources on finance available for our countries, be it annual reports of corporations, government financial budgets, supervisory information for banks, insurance corporations and pension funds, foreign direct investment, or statistics on household wealth.

The fact that interpreting financial accounts and balance sheets can be a challenge should be no excuse for not looking at them. Back in 1777, David Hume started his Essays on Commerce and Trade with a surprising warning that can apply to the intricacies (and importance) of financial accounts: “The greater part of mankind may be divided in two classes, that of shallow thinkers who fall short of the truth; and that of abstruse thinkers who go beyond it. The latter class are by far the most rare and, I may add, the most useful and valuable.”

Why is there such a lack of awareness of the system of national accounts? For a start, few university degree programmes in economics include macro-economic statistics in their curriculum. There is discussion about GDP, household disposable income and debt, but there is very little education on how these aggregates are defined, what they include or exclude, and how they are measured.

The OECD has decided to take these challenges on by publishing more accessible explanations of the basics of national accounts. Understanding Financial Accounts responds to the renewed interest in monetary and financial stability issues, and in monitoring financial risks and vulnerabilities, including their impact on growth and employment. You will not be surprised therefore to find a special emphasis on the links between the financial accounts and balance sheets and the non-financial accounts section of the system of national accounts, which deals with the “real” economy. As an example, it shows that in some countries non-financial corporations did not invest their earnings in new capital assets such as new production facilities and employment, but instead used their profits to invest in liquid financial assets. All too often, financial accounts and non-financial accounts are treated as separate systems, partly because they are compiled by different national statistical authorities, but also because policy and research frequently concentrates on one or the other.

If you are a young statistician, student, journalist, economist, or concerned policymaker, delving into national accounts will take you straight to the heart of financial developments in OECD economies. You might not be able to predict the future exactly, but you will be better able to understand and respond to it, when it comes.

Understanding Financial Accounts is the fruit of a fully co-operative effort between the OECD and the Bank for International Settlements (BIS), the European Central Bank (ECB), Fondazione AIB, the International Monetary Fund (IMF), National Central Banks (Austria, Italy and Portugal) and National Statistical Offices (Australia and Canada) and the Treasury of Canada.

Reference

van de Ven, P. and D. Fano (eds.) (2017), Understanding Financial Accounts, OECD Publishing, Paris, http://dx.doi.org/10.1787/9789264281288-en.

©OECD Insights April 2018

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