The Demand for M4: A Sectoral Analysis Part 2 The Corporate Sector

This paper is the second part of a study on the determinants of the broad money aggregate M4, following a similar analysis of the personal sector developed in Working Paper No 61. It models the broad money holdings of both industrial and commercial companies (ICCs) and other financial institutions (OFIs) in the UK, and examines what role they play in the transmission mechanism. ICCs are shown to have both a transactions and a portfolio motive for holding money. A three-equation model of money, investment and the cost of capital is estimated, and the results suggest the existence of a corporate sector liquidity channel whereby firms' "excess" money balances have a negative influence on the cost of capital and a positive impact on investment spending. OFIs' money holdings are shown to depend upon wealth and relative rates of return, in line with standard portfolio models of money demand. But as OFIs are the chief counterparts to banks' liability management activity, their money holdings are also modelled jointly with deposit rates.