Difference between Stocks and Flows of Money

This article will help you to learn about the difference between stocks and flows of money.

Difference between Stocks and Flows of Money

The twin concepts of stocks and flows are not especially difficult to understand, but they can cause great difficulty if misunderstood or misused.

To begin with, stocks and flows are both variables, they are quantities that may increase or diminish over time.

The distinction between them is that a stock is a quantity measurable at a specialised point in time, whereas a flow is a quantity that can be measured only in terms of a specialised period of time. For example, a gauge may indicate that the stock of water in a reservoir is 50 million gallons; the stock variable is 50 million gallons at this particular point in time.

It would be meaningless to describe this as 50 million gallons a year, a month, a weak, or a day. Another gauge may indicate that the flow of water into the reservoir amounted to 365 million gallons over the year then ended. Assuming that the flow was at a fixed rate over the year, this reading would also indicate that water had flowed in at a rate of 7 million gallons per weak or 1 million gallons per day.

As another example, consider the total number of persons employed in the United States—this is a stock variable. In contrast, the numbers of persons who secure new jobs or leave employment are flow variables. The number employed is say, 90 million at a point in time (on a particular day) it is nonsense to speak of the number employed as 90 million per year.

The number of persons who find employment may be, say, 100,000 for a given time period, the month of June. This is not 100,000 at a specific point in time, however.

Money is a stock, but the spending of money is a flow. To say simply that the stock of money is $375 billion has no meaning until we specify the point in time— March 31, 1980—at which this was the stock. Similarly, the statement that total spending for final output amounted to $2,629 billion is meaningless until we specify the time period, the year 1980, during which this amount was spend.

Here we can see the serious errors that can result from a failure to distinguish stocks from flows. Some people fail to make a distinction between the amount of money and the spending of money.

They simply equate the two, perhaps because whatever money they get their hands on they promptly spend. From this error follows the more serious error of imagining an increase in the stock of money to be a certain means of producing an equal increase in the flow of spending.

Far from being equal, however, the two at times do change in opposite directions to produce a combination of more money and less spending or less money and more spending. Once we realise that the variable money is a stock and the variable spending is a flow, there can be no equating of the two.

There are other illustrations of the stock flow distinction in the national income and product account. Every entry in that account is a dollar figure measuring a flow. Some of these figures such as “change in business inventories,” may at first glance appear to measure stocks.

Notice, however, that the entry is not “inventories” which is clearly a stock, but rather “change in inventories,” which is just as clearly a flow, because a change in any variable can only be measured over a period of time.

Some macroeconomic variables that have flow magnitudes also have direct counterpart stock variables. However, others—such as imports and exports, wages and salaries, tax payments, social security benefits, and dividends—are only flows, none has a direct stock counterpart (it is impossible to conceive of a “stock of imports” or a “stock of wages and salaries”).

Although such flows have no direct stock counterparts, they indirectly affect the sizes of other stocks.

Imports may affect the size of business inventories or the stock of capital goods; wage and salary receipts devoted to the purchase of newly produced houses may affect the stock of housing. For some flows that have a direct counterpart in a stock, statistics on both the stock and the flow variable are unfortunately reported under headings that are practically the same.

As in the case of employment, we can say that the stock of money averaged so many billions of dollars for the year, but again this average figure is a stock variable. For those flow variables that have a direct stock counterpart, any change in the magnitude of the stock variable between two specified points in time depends on the magnitudes of its counterpart flow variables during the period.

For example, the number of persons employed increases, decreases, or remains unchanged between two points in time, depending on the number of persons who secure employment and the number of persons who leave employment during the intervening period.

The nation’s stock of capital changes between two points in time depending on the inflow (the amount of gross investment or capital goods produced) and the outflow (the amount of capital goods consumed) during the intervening period.

Although a stock can change only as a result of flows, the magnitudes of the flows themselves may be determined in part by changes in the stock. The best example of this is the relationship between the stock of capital and the flow of investment. The stock of capital can increase only as a result of an excess of the flow of investment or of new capital goods produced over the flow of capital goods consumed.

However, the flow of investment itself depends, among other things, on the size of the capital stock. In many theories of the business cycle, a critical factor in the explanation of business downturns is a decrease in the flow of investment brought on by an “excessive” stock of capital resulting from an earlier, prolonged upsurge in the flow of investment.

This earlier upsurge in the flow of investment was usually brought on by a decrease in the stock of capital during the preceding depression when the flow of investment fell below that of the preceding period of prosperity. As is apparent, this may continue an infinitum and carry with it the endless sequence of ups and known as business cycles.

By definition, stocks can exert an influence on flows only if the time period is long enough to produce the required change in stocks. Where stocks are very large relative to flows, the changes in stocks resulting from flows are typically so small in the short-run period that stocks may be assumed to be constant in that period.

Therefore, although flows may be influenced by changes in stocks, they will not be so influenced by changes in stocks in the short run. For example, if the net effect of the flows of gross investment and capital consumption is an increase in the stock of capital between January 1 and December 31 amounting to a fraction of 1 percent of the January 1 stock of capital, then the capital stock may be assumed to be approximately constant. Because it is approximately constant, it can have no significant effect on the flow of net investment in the following period.

With respect to this relationship between the flow of investment and the stock of capital, we may define the short-run period as one in which changes in the stock of capital are too small to influence the flow of investment.

The long-run period is one in which such changes are large enough to influence the flow of investment. In this sense, elementary macroeconomic theory is primarily short-run; it is essentially a study of relationships among flows in which the size of each flow in any time period is determined solely by the sizes of other flows.

In the simplest formulation of Keynesian theory, the flow of consumer spending is determined by the flow of income, and the flow of income equals the flow of consumer spending plus the flow of investment spending.

Although we are primarily concerned with elementary theory in this article, we will devote some attention to more advanced theory in which changes in such critical stocks as the stock of capital affect the all-important flows of income and product.