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Financial Markets Notes: The Flow Of Funds And Determination Of Interest Rates

2715 words - 11 pages

TOPIC 3: The Flow of Funds and Determination of Interest RatesObjective 1Identify the main features of the role played by the different sectors of the economy in the flow of funds between surplus and deficit units.3.1 The flow of fundsIn Topic 1, one of the main functions of a nation's financial system that was identified was to facilitate the transfer of funds from surplus to deficit economic units, in primary financial markets, by the creation of new financial assets. That is to mobilise the savings of surplus economic units and transfer these funds, either directly or indirectly, to deficit units in order to finance their planned expenditure.In examining the flow of funds there are two aspects that are of interest to financial market observers:sectoral balancesinstitutional featuresThe latter aspect is concerned with the role played by different types of financial institutions in the flow of funds by means of indirect or intermediated finance. As this was examined in Topic 2, this section will focus on the sectoral balances aspect of the flow of funds.3.1.1 Sectoral balancesThe domestic economy comprises three aggregate sectors:householdscorporationsgovernmentWhen we expand our focus to the open economy, we add a fourth sector:the rest of the worldFinally, when examining the financial system, we separate out a subset of the corporations sector, because of the special role that particular organisations play in the operation of the financial system, and create a fifth sector:financial corporationsThese five aggregate sectors can be examined in terms of their overall role and position concerning the borrowing and lending of funds within the financial system. Clearly, each sector will comprise a number of both surplus and deficit units but it is the net position of the aggregate sector that is being examined.Inter-sectoral financial flowsThe statistics below are taken from the Financial Accounts compiled by the Australian Bureau of Statistics and, together with historical data, enables the main features of the sectoral balances aspect of the flow of funds to be identified.The historical and current features of each sector are outlined below:3.1.1.1 HouseholdsIn most countries the household sector is a net surplus sector. This has been the case in Australia where the household sector has traditionally been a net lender of funds to other sectors and has accumulated claims against these sectors.However, for several years during the 1990s and the 2000's in Australia, the sector became a net borrower of funds as household debt increased substantially. For these years a reduction in accumulated funds resulted. However it is expected that, with the accumulated savings of an aging population, this sector should generally remain a net surplus sectorOver 80% of the funds raised by this sector are by means of loans from banks and other deposit taking institutions.3.1.1.2 Non-financial CorporationsIn most, if not all, countries this sector is traditionally a...

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