On revaluation and the wealth effect in the national accounts

1. On revaluation and the wealth effect in the national accounts Vaclav Rybacek Financial accounts section Czech statistical office

2. Why the wealth effect? • frequently mentioned causality • theoretical relationship between changes in the wealth due to price movements and the consumption of economic agents (e.g. poeple feel richer because the value of their home or stock portflio has gone up and they increase the consumption; important case of asset bubbles and indebtedness) • revaluation of non-financial and financial assets • revaluation - potentially very important information for economic policy • How to calculate the wealth effect?

3. Revaluation in the national accounts • „[holding gains and losses] … are recorded in the national accounts, and can be used by economists to calculate the wealth effect. However, these changes in value are not recorded in the income account but in a special reveluation accounts that comes after the income account in the sequence of accounts.” [Lequiller a Blades – Understanding national accounts] • Basic stock-flow equation: • OB + T + OCH + R = CB; • OB – opening balance sheet • T – transactions • OCH – other changes in volume • R – revaluation • CB – closing balance sheet

4. Realised or un-realised? • different reaction on price changes: • realised revaluation – realisation of holding gains or losses (not so important from the wealth effect point of view) • un-realised revaluation – holding gains or losses that are only potential (reaction on „fictious“ or temporary changes in the wealth; crucial for wealth effect theoretization) • revaluation account = (realised) + (un-realised) [holding gains and losses] • separation of these two „groups“ of revaluation is infeasible, transactions should be also taken into account

5. But … • the revaluation account can answer the question: is the change in the wealth neutral or real? • revaluation account neutral holding gains and losses real holding gains and losses

6. Neutral holding gains and losses • rise or fall in the value of assets (and liabilities) that is in line with change in the general price level represented by implicit deflator of final domestic use • neutral holding gains and losses (NG): NG = p0 x q (r1/r0 – 1) ,where „p0 x q“ is current value of assets at the beginning of the period (opening stock) and r1/r0 is the factor of change in the general price level in the period

7. Real holding gains and losses • real holding gains and losses as a difference (positive or negative) between holding gains and losses and neutral holding gains and losses • RG = G – NG • rise of the value of asset > rise of the general price level = real holding gain • fall in the value of asset < fall in the general price level = real holding gain • rise of the value of liability < rise of the general price level = real holding gain, • etc.

8. Real holding gains and losses • do institutional sectors profited from the general price level movements? • real holding gains and losses are generated by: • non-financial assets • financial assets • liabilities

9. Real holding gains and losses, Czech republic, 1998-2007

10. Price indicator • two issues: a.) price index recommended by the Manual may not be adequate to the economic essence of the sectors (market production, non-market production, consumption, etc.) b.) results are highly sensitive to the choice of price index

11. Case of households … • CPI as aproximation of the general price level movement in case of households • link between main economic activity of households (consumption) and prices of consumption goods and services • results of the alternative calculations: • deflator of final domestic use: +9432 • CPI (average): -2965 • CPI (y-o-y): -132854 (!)

12. Sensitivity of results …

13. Conclusions … • realised or un-realised holding gains and losses? Complication for an assesment of sustainability of consumption rise … • is the rise in the wealth due to revaluation only nominal or real? The revaluation account can answer … • issue of price-index choice, adequacy to economic behaviour of agents (what do the agents purchase?)