1. Producing Liquidity Dennis Fixler and Kim Zieschang Society for Economic Measurement OECD, Paris July 22-25, 2015 The views expressed in this presentation are those of the authors and should not be attributed to the Bureau of Economic Analysis or to the IMF, its Executive Board, or IMF Management.

2. Liquidity services in the national accounts [1] Liquidity services (e.g., from deposits) have always been booked as produced by financial institutions (issuers of liquidity instruments) and implicitly purchased by the counterparty sectors of those institutions (holders) 1947 – Richard Stone’s Appendix to Measurement of National Income and the Construction of Social Accounts; Report of the Sub-Committee on National Income Statistics of the League of Nations Committee of Statistical Experts An income is imputed to bank depositors for the use of their money equal to the excess of interest and dividends received by banks over interest paid out and this income assumed to be used in “paying” for uncharged banking services. In the case of persons, this imputed income and outlay appears on either side of the revenue account of persons, but in the case of enterprises of all kinds, the imputed outlay is charged to the operating account, thus restricting the effect of this adjustment to the operating surplus alone. (p. 41) 1953 – A System of National Accounts and Supporting Tables same as Stone (1947) 1993, 2008 – System of National Accounts Some of the “ excess of interest and dividends received by banks over interest paid out “ is attributed to banks’ asset (e.g., loan) operations, with the remainder going to banks’ depositors (1993 and 2008 SNA) and other funders (1993 SNA) Term “Financial Intermediation Services Indirectly Measured” (FISIM) coined (1993 SNA)

3. Liquidity services in the national accounts [2] Indirectly measured deposit services (or deposit “FISIM”) = (“reference rate of interest” – monetary interest rate paid on deposits) × deposits What is the reference rate of interest? 1993 SNA – interbank lending rate (usually risk-free) 2008 SNA – rate reflecting the risk and maturity of deposits and loans, or the interbank rate Suggestion: the bank cost of capital Owners of deposits use these services, but who produces them? The issuer of the deposit (bank): the existing produced liquidity treatment The owner of the deposit (various sectors, including banks): an alternative primary service liquidity treatment Suggestion: critics of the SNA argue that it overstates the share of GDP originated by banks; primary service liquidity is a justification (different from the asset pricing basis they use) for their approach to output measurement from the deposit liabilities of banks, but only regarding these liquidity services Scope of bank funding instruments generating liquidity services 1953 SNA – deposits; 1993 SNA – all non-equity funding, including deposits; 2008 SNA – deposits Suggestion: all non-equity funding; greater consistency with instrument coverage of liquidity in monetary literature (it’s not just deposits)

4. Liquidity services in the national accounts [3] Scope of units whose liabilities are associated with liquidity SNA: financial corporations, but essentially banks within financial corporations Suggestion: Other units (nonfinancial corporations and general government) issue debt instruments and liquidity in its broadest form is associated with those instruments

5. Math: some identities Income = expense Balance sheet Reference rate (cost of capital or cost of funds, where caret indicates “security equivalent rate”) Output = input (production identity) derived from the above

6. Produced liquidity Produced liquidity is a subcomponent of the item in the production identity showing the value of services from debt funding D (including deposits) where total services from deposits can be written as and from rearrangement of the cost of funds definition

7. Primary service liquidity Remove produced liquidity from both sides of the production identity where this causes the equity leverage premium to disappear from the RHS, since from the cost of funds definition This leaves only debt (including deposit) account servicing in output Note, however, that all SNA asset FISIM is still there:

8. Some empirical results Federal Deposit Insurance Corporation (FDIC) quarterly data on all US banks (SNA Deposit taking corporations other than the central bank, S122) Annual financial statements from the Federal Reserve System (SNA Central Bank, S121) Annual Integrated Macroeconomic Accounts (IMA) of the Bureau of Economic Analysis and Federal Reserve Board of Governors

9. US Banks (FDIC data): Cost of funds/capital

10. US Banks (FDIC data): Share of produced liquidity (risk intermediation) in indirectly measured bank services (FISIM)

11. US banks (FDIC data): Trends in indirectly measured bank services (FISIM)

12. Unconventional monetary policy

13. Concluding remarks [1] Both the produced liquidity and primary service liquidity approaches can produce coherent presentations of financial services in the national accounts The produced liquidity approach—consistent with national accounts thinking since 1947—highlights the role of banks in transforming the leverage risk bearing primary service provided by equity holders into (produced) liquidity services for depositors and the other non-equity funders of banks A key linkage between the sectors originating output and the equity holding sectors of the economy Financial assets have a role in productive capital only in exploiting cost of funding advantages, and have no role if cost of funding is everywhere the same The primary service liquidity approach seems straightforward from a conventional productivity analysis point of view, but obscures the “risk intermediation” banks perform between their equity and deposit holders Financial assets are included in productive capital and are treated no differently than nonfinancial productive assets The SNA’s treatment of indirectly measured services from bank assets (e.g., loans) remains valid under either produced or primary services treatment of liquidity, assuming cost of funds/cost of capital reference rate

14. Concluding remarks [2] A satellite view of the existing produced liquidity approach under which the risk bearing services of the sectors holding bank equity are used to guarantee the debt (including deposit) funding of banks (with this guarantee or insurance service shown as a bank intermediate consumption) offers a useful perspective Should generate similar bank productivity results to conventional, nonfinancial capital only models Still tracks the impact of changes in the leverage risk bearing services through the sector production and use accounts of the economy: “linkage between the financial and real sectors of the economy” Reduces value added of banks and attributes value added of a new debt guarantee service activity to sectors holding equity in banks, thus reducing the share of banks in GDP and increasing the share of equity holding sectors Exposes the risk bearing services sectors provide that enable produced liquidity through creation of debt instruments Upshot: both the produced and primary service liquidity approaches should generate similar aggregate liquidity services and GDP, allowing for some broadening of the SNA “production boundary” for financial services, but yield different views of what sectors originate liquidity services

15. Concluding remarks [3] The banking sector is not the only sector generating produced liquidity (issuing debt yielding less than the issuing enterprise’s cost of funding) All of our identities hold with equal force for nonbanks as well as banks The SNA rules out including nonbank produced liquidity in output for the moment, but full alignment of the coverage of the liquidity services of the SNA with the broad coverage of instruments and units generating/using liquidity as understood in monetary analysis requires that nonbank liquidity services be considered, at least in a satellite analysis The linkage between the financial and real sectors is otherwise incompletely measured Similarly, in a primary services presentation of liquidity, the nonmarket production and use of liquidity by households and general government cannot be ignored when reducing the output of banks by the amount of produced liquidity

16. Including nonbank produced liquidity