Academic journal article Journal of Money, Credit & Banking

Company-Sector Money Demand: New Evidence on the Existence of a Stable Long-Run Relationship for the United Kingdom

Academic journal article Journal of Money, Credit & Banking

Company-Sector Money Demand: New Evidence on the Existence of a Stable Long-Run Relationship for the United Kingdom

Article excerpt

The demand-for-Money function is one of the central behavioral relationships in macroeconomic models. Its stability and simplicity was at the center of claims by monetarists that monetary targeting should be the backbone of a noninflationary policy stance. Monetary targets became particularly important in the 1970s when the discipline of the Bretton Woods regime had been removed. Some guiding principle for monetary policy was required.

The experience with monetary targeting was not universally successful. Targets required frequent judgmental adjustments and in some cases targeting of monetary aggregates was abandoned altogether (United Kingdom in 1986). The reason for this failure of monetary targeting was that the relationship between "money" and the economy changed. There was a succession of financial innovations that disturbed the demand function for money. In particular, the introduction of interest on current accounts reduced the velocity of circulation of narrow money aggregates in both the United Kingdom and the United States. Other major distortions in the United Kingdom were created by the abolition of the Corset (in 1980) and the provision by building societies of a full range of banking services. So great were the changes in the financial system that the U.K. authorities stopped publishing the traditional monetary aggregates M1 and M3 in 1989.

While at least one author has claimed to find a stable demand for M3 across periods of financial innovation (Taylor 1987), the general view (Hall, Henry, and Wilcox 1989) is that it is difficult to find long-run stability without making arbitrary provision for financial innovations.

A methodology already exists to account for at least some of the most important financial innovations - those involving changing interest yields on various components of money. This was first applied to monetary aggregates by William Barnett (1980) using the index number principles developed by Divisia. Barnett's approach raises some obvious questions about the economic theory underlying the particular choice of monetary aggregate [for a survey of the literature in this area see Barnett, Fisher and Serletis (1992)]. The theory suggests that the individual assets that make up "money" cannot be safely aggregated unless certain conditions are met. Only recently have formal aggregation tests been applied to the potential components of money [Belongia and Chalfont (1989) for the United States and Belongia and Chrystal (1991) for the United Kingdom]. Belongia and Chrystal found that there was a possibility that a stable long-run demand function for (Divisia) broad money existed in the United Kingdom. However, their separability tests clearly indicated that wholesale deposits should not be aggregated with retail deposits. They were also unable to find a sensible dynamic adjustment equation or error correction mechanism.

The implication we draw from this evidence is that, not only does asset aggregation have to be justified explicitly but also that sectoral aggregation needs to be investigated. It is especially likely that the corporate- and personal-sectors' behavior differ significantly - not least because the personal sector does not have access to wholesale markets.

Accordingly, we investigate corporate- and personal-sector money demand behavior separately. The present paper concentrates entirely upon the corporate sector. We proceed to test which assets can be included in an acceptable money aggregate for the corporate sector, to construct appropriate Divisia aggregates and to demonstrate that both stable long-run relationships exist for these aggregates, and that there is a sensible error correction mechanism associated with the long-run form. These results are achieved without making any special allowances for financial innovation.

1. METHODOLOGY

In this paper we follow Barr and Cuthbertson (1992) in adopting the "money in the utility function approach" in the context of the U. …

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