Flow of funds: implications for research on financial sector development and the real economy

This paper provides a selective survey of the leading theoretical and empirical issues surrounding the flow of funds: its meaning and origin, problems of construction, its use in financial modelling and its role as a tool of analysis of intersectoral financial flows. It is argued that there is an intimate connection between the flow of funds, interest rates and asset prices, and hence incomes and expenditures in an economy. The paper discusses flow of funds analysis in the context of developing countries, concentrating on possible applications and methodologies, and the issue of data collection and organization. We explore the reasons for lack of success at empirical flow of funds modelling and propose ʹpromising research ideasʹ (PRIs) to apply flow of funds analysis to study the relationship between financial sector development and the real economy, particularly to identify effective financial sector policies in developing countries.