2.1 Lending, borrowing and national income

as we shall see in Chapter 3. Another notable feature is the large accumulation of

nancial wealth in life assurance and pension funds. This has been a major outlet

for nancial saving for many years. Another interesting but small item is the gure

next to UK company shares. Notice that is negative, meaning that households as

a whole have been reducing their direct ownership of shares. This is a trend which

began in 2001 following a sharp decline in the stock market. The negative gure of

£1.2bn is very much smaller than the gures for 2001 and 2002 and may reect the

fact that some recovery in share prices had begun in 2004.

Net worth:The difference between a person or rm’s holdings of assets and liabilities.

We can trace £12.8bn of the net nancial liabilities incurred by households in

2004, as well as seeing how they rearranged their nancial assets. In acquiring these

liabilities, households are acquiring the assets of some other sector. (Mortgage loans

are assets of the banking sector.) Note that so far as households are concerned,

acquiring these additional liabilities amount to new borrowing which they are

undertaking; it is ‘new’ in the sense that it is additional to any borrowing which they

may have done in 2003, for example. Thus (we need to emphasise) it is a ow. That

is to say it must be measured and expressed with reference to a period of time. Here

we have examined the ow in just one year, 2004. This owof new borrowing, or

acquisition of liabilities, adds to the existing stock of such liabilities which house-

holds already hold. (The same is true of the nancial assets that households acquired

in the same period.) We might refer to this existing stock as households’ existing

‘net nancial wealth’ and it will be a proportion of their total wealth (the rest con-

sisting typically of a house and various consumer durable goods). Notice that the

stock is the sum of previous ows and is measured at a particular point in time.

Clearly, therefore, the (ow) net acquisition of nancial assets causes the stock of

assets held to change. Indeed, it is often the case that the change in a stock is equal

to the net ow (inow minusoutow) into it. This is rather like a tank of water where

the level (the stock) of water rises if there is a net inow and falls if there is a net

outow. In other words, if we were to compare the stock gures for 2005 with those

for 2004, the difference would correspond to the gures in Table 2.2.

However, there is sometimes a complication in nancial accounts which arises

from the fact that the stock of assets contains some assets which are tradable. They

have a market price and this price may uctuate. Thus the change in the value of a

stock of nancial assets between two periods of time will be the result of boththe net

acquisition (positive or negative) andany change in the market price of the existing

assets. Using our current data, for example, the stock of UK company shares held by

households in 2005, might not be exactly £1.2bn lower than it was in 2004, because

the price of the shares still held may have changed. (In fact, they rose quite sharply

between 2004 and 2005.)

Before leaving this discussion of the stock/ow relationship, notice also that the

existing stock is always likely to be larger than the current ow (because it has built

up over the years). Notice too that there is no requirement that the assets acquired

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Chapter 2 • The nancial system and the real economy

in the current ow are an exact replica of the assets currently held. For example, new

assets may be developed and added to the stock for the rst time. Other, traditional,

assets may then lose their appeal, and while they remain in the stock there may be

no new purchases. As rates of return, and levels of risk, on assets vary from time

to time, we would expect to see variations in the demand for them. There will be

changes in the composition of the ow of newly acquired assets and this will affect

the composition of the stock over time.

Exercise 2.1

Imagine that you are the manager of a mutual fund consisting entirely of a portfolio which exactly matches the composition of the FTSE-100 index. At the beginning of the year the value of your fund is £500m. In the rst week of the year, you receive £12m in additional funds from investors. In the last week, existing investors withdraw £5m from the fund. During the year, the price of shares in the FTSE-100 index increases by 15 per cent.

(a)	Calculate the change in the value of your fund’s stock of assets over the year.
(b)	What is the net inow of funds during the year?
(c)	How much of the change is explained by the rise in price of assets in the fund? Answers at end of chapter

Table 2.3 shows the stockof nancial assets and liabilities held by the house-

hold sector at the endof 2004. Information on stocks of assets and liabilities comes

from balance sheet data. Table 2.3 uses the same categories as Table 2.2, so that

comparisons can be made easily. Even the briefest glance reveals that the stocks of

assets already held are very much larger than the current ows. The table shows that

total nancial assets amounted to £3,179bn while nancial liabilities amounted to

£1,194.4bn. Household nancial net worth at end-2004 therefore was £1,984.6bn.

We know that it decreased during the year by £12.8bn.

Table 2.3Financial balance sheet of the household sector, end-2004 £bn

Financial assetsFinancial liabilities

Notes and coin	33.7	Loans – short-term	184.3
Deposits with banks	558.3	– mortgage	874.9
and building societies	156.3	– other long-term	23.8
Other deposits	109.9	Other liabilities	111.4
Bills and bonds	51.2	Total nancial liabilities	1,194.4
UK company shares	343.1
Other shares	15.8
Mutual funds	142.7
Life assurance and	1,668.4
pension funds
Other	99.6
Total nancial assets	3,179

Source: ONS, UK National Accounts, 2005, Table 6.1.9

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