- Email: [email protected]
The stability of the demand for money: The case of the corporate sector
MYRON B. SLOVIN MARIE ELIZABEIH SUSHKA Georgia Institute
of Technology
The Stability of the Demand for Money: The Case of the Corporate Sector Although there is general consensus on the determinants of the demand for money, the empirical performance of such money-demand equations has been unstable and poor in forecasting. In this study, the demand for money is empirically investigated on a disaggregated basis, by major sector, using Flow of Funds data, 1955i-197%. The results indicate that the empirical difficulties are specific to the corporate sector, that the problems in the corporate sector emerged during the later 1969s, and that foreign economic activity has become an important component in explaining holdings of cash by the corporate sector.
In recent years, a considerable degree of consensus has emerged as to the determinants of the demand for money.’ Despite this consensus, the topic of money demand remains an important empirical issue. In particular, during the past few years econometric experience has indicated that such money-demand equations have proven to be unstable and to be poor predictors.’ The purpose of this paper is to gain insight into the behavior of money demand by using a disaggregated approach, more specifically, by using Federal Reserve flow of funds data to investigate the degree to which the typical specification based upon the inventory-theoretic approach is capable of providing an adequate description of the behavior of each of the major groups of money-demand holders. The basic empirical specification used in this paper is based upon Goldfeld’s (1976) specification which has become a standard formulation in the recent money-demand literature. The specific form of this equation is:
‘For a comprehensive review of the literature (1977) or Goldfeld (1973). ‘Goldfeld (1976) has termed the poor prediction the problem of the “missing money.” A review found in Judd and Scadding (1982).
]ournal Copyright
of Macroeconomics, 8
1984
by Wayne
Summer 1983, State University
Vol.
on money
of
demand,
see
Laidler
capabilities of money demand, the literature on this issue is
5, No. Press.
3, pp.
361-372
361
Myron
B. Slovin and Marie Elizabeth ln(M,/P,)
Sushka
= b, + bJn(Y,/PJ
+ bJn r
+ (1 - VWM,-A’-J
,
where M is the relevant money balances, P is the price level, Y is income, r is the rate of interest, and A is the speed of adjustment. Our estimation period is 1955i-1976iv on a quarterly basis.3 Because the data are unadjusted end-of-quarter levels, seasonal dummies are included in each regression.4 Furthermore, equations are estimated using the Cochrane-Orcutt correction for serial correlation and all variables are entered logarithmically. When the standard formulation of the money-demand specification is applied to the balances held by the household sector, the financial sector, and the state and local government sector, the results are similar to those reported in Goldfeld (1976) and generally appear consistent with the implications of the inventory-theoretic approach. These results are not reported here, but can be obtained from the authors upon request. However, the results indicate that although the inventory-theoretic specification is capable of describing the behavior of the demand for money held in the economy outside of the corporate sector, the demand for money on the part of the corporate sector seems less susceptible to analysis using standard inventory money-demand specifications. In this paper, we utilize data for the corporate sector per se and exclude balances for the farm and nonfarm noncorporate (proprietorships) sectors which are included under the broader category of nonfinancial business. Our approach is in contrast to Goldfeld’s (1976) approach where he utilizes data for the broader category of nonfinancial business to which he adds mail float. To the extent that the business sector optimizes balances in accordance with the predictions of inventory theory, it can be hypothesized that it should be the corporate sector per se whose behavior should be described by specifications drawn from inventory theory. Moreover, the data collected from the corporate sector for the flow of funds are more
3We have not included the years prior to 1955, unlike Goldfeld (1973), because Modigliani, Rasche, and Cooper (1970) suggest that these years were characterized by distortions in the pattern of money-demand holdings as a result of the effects of the Korean war economy. 4Seasonal dummies are entered for the second, third, and fourth quarters so that the implied seasonal for the first quarter is obtained as the value of the constant less the sum of the other three seasonal coefficients.
362
Demand
for Money,
Corporate
Sector
likely to be accurate than those derived from the noncorporate business sector due to the extensive reporting requirements of the corporate sector. Overall, our findings have three important implications: 1) The empirical (and specifically the forecasting) difficulties that have characterized the behavior of the demand for money function are specific to the corporate sector’s demand. 2) The problems in the corporate sector emerged during the 1960s and the early 1970s rather than during the mid-1970s.’ 3) The difficulties with the corporate demand for money during the 1970s appear to be related to the omission of the effects of foreign economic activity on holdings of cash by the corporate sector.
1. Problems
in Money
Demand
by the Corporate
Sector
Our empirical results for the behavior of the demand for money by the corporate sector are much less acceptable than the results for the other sectors. This can be seen by examination of the estimation results for the standard specification for the corporate sector, reported as Equation (1) in Table 1. As a measure of transactions, we use real nonfarm business product, and we use the commercial paper rate (RCP) as a measure of the opportunity cost of holding money. Although the nonfarm business product and the commercial paper rate each have the correct sign, each variable obtains a small coefficient and neither is statistically significant. Moreover, the R2 is relatively low and the standard error high. These results, which are for the balances held in the corporate sector per se, are noticeably worse than those obtained by Goldfeld (1976) for the broader nonfinancial business sector which yielded significant coefficients on all of these variables and a much higher R2. Unlike Goldfeld (1976), we have excluded the farm and noncorporate business sectors which could be viewed as less likely to be characterized by substantial interest rate sensitivity relative to the corporate sector which is presumably quite conscious of the implications of minimizing balances. Nevertheless, the results in Table 1 imply that the degree of interest elasticity of the corporate demand for money is low, if not zero, and is much smaller than any of the other sectors analyzed. We attempted to obtain more significant interest rate results by experimenting with alternative market interest rates, but ‘Goldfeld behavior are
(1976) unique
concluded that the problems to the 1974-1976 period.
associated
with
money-demand
363
1955-1976
1955-1976
1955-1976
1955-1973
1955-1973
1955-1973
1
2
3
4
5
6
0.8577 (15.10)** 0.8607 (15.05)** 0.8563 (15.21)** 0.8686 (13.72)** 0.8687 (13.86)** 0.8558 (13.94)**
Lagged Money
Corporate
-0.0065 (-0.43) -0.0173 (-0.99) -0.0126 (-0.70)
-0.0036 (-0.27)
RCP 0.0255 (1.21) 0.0274 (1.29) 0.0206 (1.59) 0.0350 (1.42) -0.0291 (-0.25) 0.0222 (0.17)
Business Product
Nonfarm
Money-Demand
-0.0040 (-0.39)
RFF
0.0404 (0.55)
mercial Loans
com-
Equations”
0.0073 (0.08)
Trade Credit
0.154
0.222
0.266
-0.087
-0.132
-0.049
-0.029
0.197 0.143
-0.025
eRb
0.179
eRBpb 0.1202 (9.18)** 0.1190 (9.17)** 0.1187 (9.22)** 1.220 (8.71)** 0.1236 (9.22)** 0.1220 (8X3)**
S2’ 0.1002 (9.64)** 0.0988 (9.42)** 0.0983 (9.46)** 0.1036 (9.32)** 0.1034 (9.94)** 0.1035 (9.16)**
S3’ 0.1617 (13.04)** 0.1609 (13.10)** 0.1603 (13X2)** 0.1665 (12.54)** 0.1649 (12.93)** 0.1661 (11.89)**
S4’
0.6025 (1.64) 0.5714 (1.51) 0.6383 (1.86)* 0.4758 (1.20) 0.9161 (1.20) 0.5891 (1.22)
Constant
0.7404 0.0325 0.7406 0.0325 0.7434 0.0323 0.7391 0.0336 0.7636 0.0321 0.7626 0.0321
R2 SE
'Primary SOWC~S for dl data series: Federal Reserve data bank for FMP model, Federal Reserve Flow of Funds data bank. The t-statistics parenthesis; **significant at the five-percent level; *significant at the ten-percentlevel. ‘e = long term elasticities where subscripts refer to transactions variables,NBP,and the appropriateinterestrate variable,R. ‘S2, S3, S4 are quarterly seasonals.
Sample Period
1.
Equation
TABLE
are in
2.02 -0.25 2.02 -0.28 2.02 -0.25 2.57 -0.26 2.01 -0.29 2.00 -0.26
DW RHO
Demand
for Money,
Corporate
Sector
in no case could we obtain statistically significant coefficients which were superior to the commercial paper rate. As an indication of this, in Equation (2) in Table 1, the commercial paper rate is replaced by the federal funds rate (RFF) but the overall character of the equation remains the same. Even when the equation is specified with only a transactions variable, real business product, the empirical results in Equation (3) remain poor. One possible explanation for the poor results obtained in Equations (l)-(3) of Table 1 is that the sample period includes the post-1973 years (1974-1976). Since Goldfeld (1976) has suggested that something has gone astray during this period, “the missing money” in his terminology, we reestimated the corporate equation over the period 1955-1973, thus excluding the suspect twelve quarters. The results, reported in Equation (4) in Table 1, indicate that there is little change in the behavior of the equation from our initial results over the longer sample. To formally test whether there was any change in the estimated coefficients, we calculated an Fstatistic in order to test the null hypothesis that these twelve quarters come from the same population as the equation estimated over the 1955-1973 period. The F-test results indicate that there is no evidence that these twelve quarters are drawn from a different population.6 Thus, it appears that the difficulty associated with applying the inventory theory to the demand for corporate balances cannot be ascribed to a recent shift in the function as suggested by Goldfeld, that is, the difficulties with respect to the behavior of the corporate demand for money apparently predate the 1974-1976 period. The major implications of these results are that 1) the “missing money” can be isolated as a problem within the corporate sector, and 2) the problem in the corporate sector is not specific to the 1974-1976 period, as Goldfeld suggests, but instead has its origins prior to that period. A second possible explanation for the poor pattern of corporate-sector results is that corporate cash balances are held primarily as compensating balances at banks which serve as a means of remuneration for commercial loans or other corporate services. Such a view has been suggested, for example, by Sprenkle (1971). This is a difficult hypothesis to test, however, since compensating balances can provide payment for a wide variety of services that are provided by banks to their corporate customers but which are, in
level
‘The calculated is 1.90.
F is 0.60,
while
the
relevant
tabular
value
of F at the
S-percent
Myron
B. Slovin and Marie
Elizabeth
Sushka
general, difficult to quantify. One possibility is that the quantity of commercial loans can serve as a proxy for the provision of such services and thus the need for corporations to maintain compensating balances. When such a commercial loan variable is added to the basic specification, however, the empirical results are poor as can be seen by examining the coefficients reported in Equation (5) in Table 1. This implies that the volume of such loans has little influence on corporate money demand. A third alternative explanation for the poor behavior of the corporate demand for money is that it may be attributed to the expansion of trade credit during recent decades. More specifically, growth in trade credit may serve to reduce the optimal level of balances which firms must maintain on average in order to finance their transactions. When the volume of trade credit is added as an additional variable to the specification for the corporate demand for money, however, it has little statistical effect, as can be seen by examining the pattern of coefficients reported in Equation (6) of Table 1.
2. Structural Instability in the Corporate Sector It is possible that there are important measurement errors in the breakdown of ownership of money balances among the various holders. Nevertheless, this does not seem a likely explanation for the poor corporate results. First, since the data collected for the flow of funds reflect direct corporate reporting, it is the corporate data which are likely to be the most accurate, especially since household data are mainly obtained as residuals to other sectors’ reporting. Second, if errors in apportioning funds among the various sectors were responsible for the poor corporate results, it would be unlikely that we would obtain results for all of the remaining sectors that are so consistent with the implications of an inventory model of money demand. In order to provide some insight into the question of when the deterioration in the behavior of the corporate demand for money occurred, we reestimated the equation for corporate balances over three separate subperiods: 1955-1962, 1963-1968, and 1969-1973. It should be noted that these periods still lie within the time span prior to I974 so they cover a period that Goldfeld would agree is relatively normal. The choice of these subperiods reflects several considerations. The subperiod 1955-1962 covers a calm period in financial markets that is prior to the growth of the negotiable cer366
Demand
for
Money,
Corporate
Sector
tificate of deposit (CDs) market. Furthermore, previous evidence [Slovin and Sushka (1975)] is consistent with a structural shift in money-demand behavior at that time. The years 1963-1968 cover a period which witnessed the development and the substantial growth of corporate cash management techniques and the emergence of a new and growing open market asset, CDs, yet at the same time general money-market conditions were relatively calm. The subperiod after 1968, however, was one of much higher and more volatile interest rates. The estimation results for the regressions representing each subperiod are reported as Equations (l), (2), and (3) of Table 2. The evidence from these regressions indicates that corporate demand for money deteriorated earlier than 1973. More specifically, the specification provides a relatively good description of the period of the 1950s and early 1960s. The regression for the sample period 1955-1962, Equation (l), indicates that both the transactions variable, real business product, and the commercial paper rate (RCP) have the correct signs and are significant, although the implied speed of adjustment per quarter is a slow 7 percent. The R2 is high and the standard error low, although the implied long run elasticity of money with respect to business product, eNBp, appears unrealistically high, but this can be attributed to the implausibly slow speed of adjustment for which we have no a priori explanation. Equation (2) estimated over the period 1962-1968 produces somewhat different results although this period can be viewed as relatively calm without the kind of serious disruptions in the financial market which have occurred periodically since 1968. Each of the variables has the correct sign but neither the transactions variable nor the commercial paper rate is significant. Moreover, there is a substantial increase in the speed of adjustment to 37 percent per quarter and a substantial decrease in the long run elasticity of business product (eNBr) to a more reasonable 0.9. The implied interest rate elasticity (eR) remains high at about 0.42. The R2 is relatively low and the standard error relatively high. Furthermore, the calculation of the F-statistic indicates that we can reject, at the 5percent level of significance, the hypothesis that the 1963-1968 is drawn from the same population as the pre-1963 period.7 This suggests that the corporate demand for money began to shift earlier than 1973. The estimation results obtained by applying this speci-
level
‘The calculated is 2.25.
F is 2.84
while
the
relevant
tabular
value
of F at the
5-percent
367
Myron
B. Slovin and Marie Elizabeth
TABLE 2. Corporate Equation 1
Sample Period 1955-1962
Money-Demand
Lagged Money 0.9294 (11.07)**
2 3 4
5 6 7 8
1963-1968 1969-1973 1955-1968 1969-1973 1969-1976 1969-1976 1969-1976
RCP
Sushka Equations’ Nonfarm Business Product
-0.0446
0.1556
(-3.04)**
(3.01)**
0.6273
-0.1560
0.3321
(3.45)**
(-1.53)
(1.54)
0.1930
0.0322
-0.4838
(0.66)
(0.93)
(-2.24)**
0.7432
-0.0451
0.0634
(9.13)**
(-2.44)**
(2.09)**
0.1857
-0.4764
(0.66)
(-2.07)**
0.5419
0.0116
-0.3272
(3.40)**
(0.55)
(-2.59)**
FGNP
0.2574
-0.0153
0.4671
-0.9231
(1.86)*
(-1.10)
(2.32)**
(-4.20)**
REB
0.2803
0.4741
-0.9137
-0.0198
(2.14)**
(2.47)**
(-4.40)**
(-1.40)
“Primary sources for all data series: Federal Reserve data bank for FMP model, **significant at the five-percent level; *significant at the ten-percent level. be = long term elasticities; NBP subscript indicates nonfarm business product; 52, S3, S4 are quarterly seasonals.
fication over the combined period 1955-1968 are reported as Equation (4) in Table 2 and, although sensible, do not closely resemble the results obtained for either subperiod. Each variable is significant with the correct sign, and the speed of adjustment is a reasonable 26 percent per quarter but the long run elasticities of business product (eNBP)and interest rates (es) are much lower than for either subperiod taken separately. Thus, although the evidence suggests that the corporate demand for money shifted during the 196Os, it did so in a manner that seems reasonable and consistent with the growth of more effective cash management, as predicted by the inventory model. In particular, the degree of interest elasticity rose sharply as did the speed of adjustment to magnitudes that are probably more realistic than the estimates obtained for the period of the 1950s. The estimation results deteriorate considerably, however, for the third subset of observations, 1969-1973, in a way that appears 368
Demand
b
b eNBP
2.204 0.891 -0.600 0.364
S2”
eR
-0.632 -0.419 0.040 -0.176
-0.585 -0.714
0.025
0.628
-0.021
0.659
-0.028
Federal R subscript
Reserve indicates
for
S3”
0.1304
0.1067
(8.30)**
0.1114
(9.27)** 0.0801
(3.70)**
(3.40)**
0.0173 (0.57) 0.0156
0.0376 (1.19)
0.0353
(0.51)
(1.14)
Money,
Corporate
Constunt
s4
0.1666 -0.6119 (12.17)**
(-0.86)
Sector
R2 SE
DW Rho
0.8739
1.96
0.0209
-0.30
2.07 -0.08 1.41 0.24 2.07 -0.26 1.50 0.35
0.1790
0.1744
0.7434
(7.12)**
(0.11)
0.0293
0.0834
8.1052
0.7438
(3.31)**
(2.63)**
0.0284
0.0823
1.0857
0.7753
(3.26)**
(2.04)**
0.0276
0.0880 (3.89)**
8.1584 (2.65)**
0.7062 0.0304
0.0205 0.0437 (0.73) (1.62) 0.0625 0.0699 (2.99)** (3.67)** 0.0326 0.0468 (1.75)* (3.01)** 0.0353 0.0502
0.1117
4.9688
0.7860
(6.13)**
(2.87)**
0.0307
-0.50
0.0978 (6.37)**
5.5942 (4.43)**
0.8722 0.0237
0.1002
5.3679
0.8752
(1.89)*
(6.43)**
(4.47)**
0.0235
2.02 -0.18 2.03 -0.22
Flow
of the
(3.34)** Funds
relevant
data interest
bank.
The
t-statistics
are
in
1.92
parenthesis;
rate.
difficult to rationalize. Neither the commercial paper rate nor business product have the correct sign and the coefficient of the constant rises dramatically as reported in Equation (3). In fact, real business product has a coefficient of -0.48 and is statistically significant, an especially disturbing result. Even when the commercial paper rate is excluded, business product still obtains the wrong sign as illustrated by the results in Equation (5). Again, an F-test for structural stability rejects the hypothesis that this third subperiod is drawn from the same population as either the 1958-1962 or the longer 1958-1968 period.’ When the specification is estimated over the sample period 1969-1976, the pattern of the estimated coefficients remains the same as reported in Equation (6), with the transactions variable still negative and significant. Moreover, the ‘The calculated tabular values of
values of F are F at the S-percent
3.26 and 4.15, respectively, level are 2.26 and 2.14.
while
the
relevant
Myron
B. Slovin and Marie Elizabeth
Sushka
results obtained from an F-test for structural stability again suggest that there is no evidence that the period 1974-1976 is drawn from a population different from that of 1969-1973.’ In general, since the subperiod estimation results differ so much between the three periods, it is not surprising that the full-period estimation results are so poor for the corporate sector. Thus, the empirical results suggest that the narrowly defined corporate sector’s demand for money balances has not been stable and that its behavior during the 1970s cannot be easily rationalized on the basis of the inventory theory of money demand that is so commonly and routinely applied in aggregate demand for money studies.
3. International
Components
of Corporate
Money
Demand
These results for the corporate sector are disturbing since many financial economists generally presume that the corporate sector is conscious of optimizing cash balances and suggest that some important element of the economic environment of the 1970s must be missing from the standard money-demand specification. Our hypothesis is that this missing element may be international influences. Most large American corporations are international in scope and, given the degree of integration that pervades the international economy, the distribution of corporate cash holdings between domestic banks and those abroad may be sensitive to the relative levels of economic activity at home and abroad. In order to test this hypothesis, an index of foreign income (FGNP) is added to specification and the results are reported in Equation (7) of Table 2.” The foreign GNP variable is negative and significant as expected, with a t-statistic in excess of 4. Moreover, the coefficient of domestic business product changes sign and becomes significantly positive. In addition, there is a dramatic reduction in the standard error of the regression by about 20 percent and a concomitant rise in the R2. Although the coefficient of the commercial paper rate is not significant, it becomes negative. When the Eurodollar deposit rate (REB) is substituted for the domestic commercial paper rate, Equation (8), the results are somewhat better. Although this inter‘The calculated value of F is 1.35 while the relevant tabular value of F at the 5-percent level is 2.69. “‘This series is a weighted average of real GNP for the following countries, where the weights are the bilateral trade shares: Canada, Germany, Japan, United Kingdom, France, Italy, Netherlands, Belgium, Sweden, and Switzerland.
370
Demand
for Money,
Corporate
Sector
est rate variable is still not significant, the size and sign of the interest elasticity (es) is reasonable. l1 These results imply that although corporations optimize cash balances in a manner predicted by the inventory model, because their transactions and their cash are held worldwide, domestic holdings of cash by corporations are sensitive to economic activity abroad. Thus, the evidence indicates that the integration of economic activity across international borders may have become an important factor in explaining financial behavior at American corporations.
4. Conclusion Overall, although the power of the inventory-theoretic approach is impressive with respect to its ability to describe the demand for money held in the economy outside of the corporate sector, the behavior of the demand for money on the part of the corporate sector seems much less susceptible to analysis using the standard specification of the inventory model. The problem, however, is not the inability of a corporate equation to explain the 19741976 period; rather, that the simple inventory model does not imply stability in the corporate demand for money over the 1950s and the 1960s and does not appear applicable to the 1970s. The apparent explanation for the difficulties with such equations for the 1970s appears to be related to the omission of the influence of the level of foreign economic activity on the domestic holdings of cash by the corporate sector. Received: June 1981 Final oersion received:
November
1982
References Goldfeld, S. “The Case of the Missing Money.” Brookings Papers on Economic Activity 3 (1976): 683-740. -. “The Demand for Money Revisited. ” Brookings Papers on Economic Activity 3 (1973): 557-638. Judd, J. and J. &adding. “The Search for a Stable Money Demand
“Essentially identical results are obtained for rate. Because of the presence of multicollinearity, tained whenever attempts were made to include specification.
the CD rate or the federal funds poor estimation results were obtwo interest rate variables in the
371
Myron
B. Slovin and Marie
Elizabeth
Sushka
Function: A Survey of the Post-1973 Literature.” Journal of Economic Literature (September 1982): 993-1023. Laidler, D. The Demand for Money: Theories and Evidence. Scranton: International Textbook Company, 1977. Modigliani, F., R. Rasche, and J. Cooper. “Central Bank Policy, the Money Supply and the Short Term Rate of Interest. ” Journal of Money, Credit, and Banking (May 1970): 166-218. Slovin, M. and M. Sushka. “The Structural Shift in the Demand for Money. ” Journal of Finance (June 1975): 721-31. Sprenkle, C. Effects of Large Firm and Bank Behavior on the Demand for Money of Large Firms. Washington, D.C.: American Bankers Association, 1971.
372
of Technology
The Stability of the Demand for Money: The Case of the Corporate Sector Although there is general consensus on the determinants of the demand for money, the empirical performance of such money-demand equations has been unstable and poor in forecasting. In this study, the demand for money is empirically investigated on a disaggregated basis, by major sector, using Flow of Funds data, 1955i-197%. The results indicate that the empirical difficulties are specific to the corporate sector, that the problems in the corporate sector emerged during the later 1969s, and that foreign economic activity has become an important component in explaining holdings of cash by the corporate sector.
In recent years, a considerable degree of consensus has emerged as to the determinants of the demand for money.’ Despite this consensus, the topic of money demand remains an important empirical issue. In particular, during the past few years econometric experience has indicated that such money-demand equations have proven to be unstable and to be poor predictors.’ The purpose of this paper is to gain insight into the behavior of money demand by using a disaggregated approach, more specifically, by using Federal Reserve flow of funds data to investigate the degree to which the typical specification based upon the inventory-theoretic approach is capable of providing an adequate description of the behavior of each of the major groups of money-demand holders. The basic empirical specification used in this paper is based upon Goldfeld’s (1976) specification which has become a standard formulation in the recent money-demand literature. The specific form of this equation is:
‘For a comprehensive review of the literature (1977) or Goldfeld (1973). ‘Goldfeld (1976) has termed the poor prediction the problem of the “missing money.” A review found in Judd and Scadding (1982).
]ournal Copyright
of Macroeconomics, 8
1984
by Wayne
Summer 1983, State University
Vol.
on money
of
demand,
see
Laidler
capabilities of money demand, the literature on this issue is
5, No. Press.
3, pp.
361-372
361
Myron
B. Slovin and Marie Elizabeth ln(M,/P,)
Sushka
= b, + bJn(Y,/PJ
+ bJn r
+ (1 - VWM,-A’-J
,
where M is the relevant money balances, P is the price level, Y is income, r is the rate of interest, and A is the speed of adjustment. Our estimation period is 1955i-1976iv on a quarterly basis.3 Because the data are unadjusted end-of-quarter levels, seasonal dummies are included in each regression.4 Furthermore, equations are estimated using the Cochrane-Orcutt correction for serial correlation and all variables are entered logarithmically. When the standard formulation of the money-demand specification is applied to the balances held by the household sector, the financial sector, and the state and local government sector, the results are similar to those reported in Goldfeld (1976) and generally appear consistent with the implications of the inventory-theoretic approach. These results are not reported here, but can be obtained from the authors upon request. However, the results indicate that although the inventory-theoretic specification is capable of describing the behavior of the demand for money held in the economy outside of the corporate sector, the demand for money on the part of the corporate sector seems less susceptible to analysis using standard inventory money-demand specifications. In this paper, we utilize data for the corporate sector per se and exclude balances for the farm and nonfarm noncorporate (proprietorships) sectors which are included under the broader category of nonfinancial business. Our approach is in contrast to Goldfeld’s (1976) approach where he utilizes data for the broader category of nonfinancial business to which he adds mail float. To the extent that the business sector optimizes balances in accordance with the predictions of inventory theory, it can be hypothesized that it should be the corporate sector per se whose behavior should be described by specifications drawn from inventory theory. Moreover, the data collected from the corporate sector for the flow of funds are more
3We have not included the years prior to 1955, unlike Goldfeld (1973), because Modigliani, Rasche, and Cooper (1970) suggest that these years were characterized by distortions in the pattern of money-demand holdings as a result of the effects of the Korean war economy. 4Seasonal dummies are entered for the second, third, and fourth quarters so that the implied seasonal for the first quarter is obtained as the value of the constant less the sum of the other three seasonal coefficients.
362
Demand
for Money,
Corporate
Sector
likely to be accurate than those derived from the noncorporate business sector due to the extensive reporting requirements of the corporate sector. Overall, our findings have three important implications: 1) The empirical (and specifically the forecasting) difficulties that have characterized the behavior of the demand for money function are specific to the corporate sector’s demand. 2) The problems in the corporate sector emerged during the 1960s and the early 1970s rather than during the mid-1970s.’ 3) The difficulties with the corporate demand for money during the 1970s appear to be related to the omission of the effects of foreign economic activity on holdings of cash by the corporate sector.
1. Problems
in Money
Demand
by the Corporate
Sector
Our empirical results for the behavior of the demand for money by the corporate sector are much less acceptable than the results for the other sectors. This can be seen by examination of the estimation results for the standard specification for the corporate sector, reported as Equation (1) in Table 1. As a measure of transactions, we use real nonfarm business product, and we use the commercial paper rate (RCP) as a measure of the opportunity cost of holding money. Although the nonfarm business product and the commercial paper rate each have the correct sign, each variable obtains a small coefficient and neither is statistically significant. Moreover, the R2 is relatively low and the standard error high. These results, which are for the balances held in the corporate sector per se, are noticeably worse than those obtained by Goldfeld (1976) for the broader nonfinancial business sector which yielded significant coefficients on all of these variables and a much higher R2. Unlike Goldfeld (1976), we have excluded the farm and noncorporate business sectors which could be viewed as less likely to be characterized by substantial interest rate sensitivity relative to the corporate sector which is presumably quite conscious of the implications of minimizing balances. Nevertheless, the results in Table 1 imply that the degree of interest elasticity of the corporate demand for money is low, if not zero, and is much smaller than any of the other sectors analyzed. We attempted to obtain more significant interest rate results by experimenting with alternative market interest rates, but ‘Goldfeld behavior are
(1976) unique
concluded that the problems to the 1974-1976 period.
associated
with
money-demand
363
1955-1976
1955-1976
1955-1976
1955-1973
1955-1973
1955-1973
1
2
3
4
5
6
0.8577 (15.10)** 0.8607 (15.05)** 0.8563 (15.21)** 0.8686 (13.72)** 0.8687 (13.86)** 0.8558 (13.94)**
Lagged Money
Corporate
-0.0065 (-0.43) -0.0173 (-0.99) -0.0126 (-0.70)
-0.0036 (-0.27)
RCP 0.0255 (1.21) 0.0274 (1.29) 0.0206 (1.59) 0.0350 (1.42) -0.0291 (-0.25) 0.0222 (0.17)
Business Product
Nonfarm
Money-Demand
-0.0040 (-0.39)
RFF
0.0404 (0.55)
mercial Loans
com-
Equations”
0.0073 (0.08)
Trade Credit
0.154
0.222
0.266
-0.087
-0.132
-0.049
-0.029
0.197 0.143
-0.025
eRb
0.179
eRBpb 0.1202 (9.18)** 0.1190 (9.17)** 0.1187 (9.22)** 1.220 (8.71)** 0.1236 (9.22)** 0.1220 (8X3)**
S2’ 0.1002 (9.64)** 0.0988 (9.42)** 0.0983 (9.46)** 0.1036 (9.32)** 0.1034 (9.94)** 0.1035 (9.16)**
S3’ 0.1617 (13.04)** 0.1609 (13.10)** 0.1603 (13X2)** 0.1665 (12.54)** 0.1649 (12.93)** 0.1661 (11.89)**
S4’
0.6025 (1.64) 0.5714 (1.51) 0.6383 (1.86)* 0.4758 (1.20) 0.9161 (1.20) 0.5891 (1.22)
Constant
0.7404 0.0325 0.7406 0.0325 0.7434 0.0323 0.7391 0.0336 0.7636 0.0321 0.7626 0.0321
R2 SE
'Primary SOWC~S for dl data series: Federal Reserve data bank for FMP model, Federal Reserve Flow of Funds data bank. The t-statistics parenthesis; **significant at the five-percent level; *significant at the ten-percentlevel. ‘e = long term elasticities where subscripts refer to transactions variables,NBP,and the appropriateinterestrate variable,R. ‘S2, S3, S4 are quarterly seasonals.
Sample Period
1.
Equation
TABLE
are in
2.02 -0.25 2.02 -0.28 2.02 -0.25 2.57 -0.26 2.01 -0.29 2.00 -0.26
DW RHO
Demand
for Money,
Corporate
Sector
in no case could we obtain statistically significant coefficients which were superior to the commercial paper rate. As an indication of this, in Equation (2) in Table 1, the commercial paper rate is replaced by the federal funds rate (RFF) but the overall character of the equation remains the same. Even when the equation is specified with only a transactions variable, real business product, the empirical results in Equation (3) remain poor. One possible explanation for the poor results obtained in Equations (l)-(3) of Table 1 is that the sample period includes the post-1973 years (1974-1976). Since Goldfeld (1976) has suggested that something has gone astray during this period, “the missing money” in his terminology, we reestimated the corporate equation over the period 1955-1973, thus excluding the suspect twelve quarters. The results, reported in Equation (4) in Table 1, indicate that there is little change in the behavior of the equation from our initial results over the longer sample. To formally test whether there was any change in the estimated coefficients, we calculated an Fstatistic in order to test the null hypothesis that these twelve quarters come from the same population as the equation estimated over the 1955-1973 period. The F-test results indicate that there is no evidence that these twelve quarters are drawn from a different population.6 Thus, it appears that the difficulty associated with applying the inventory theory to the demand for corporate balances cannot be ascribed to a recent shift in the function as suggested by Goldfeld, that is, the difficulties with respect to the behavior of the corporate demand for money apparently predate the 1974-1976 period. The major implications of these results are that 1) the “missing money” can be isolated as a problem within the corporate sector, and 2) the problem in the corporate sector is not specific to the 1974-1976 period, as Goldfeld suggests, but instead has its origins prior to that period. A second possible explanation for the poor pattern of corporate-sector results is that corporate cash balances are held primarily as compensating balances at banks which serve as a means of remuneration for commercial loans or other corporate services. Such a view has been suggested, for example, by Sprenkle (1971). This is a difficult hypothesis to test, however, since compensating balances can provide payment for a wide variety of services that are provided by banks to their corporate customers but which are, in
level
‘The calculated is 1.90.
F is 0.60,
while
the
relevant
tabular
value
of F at the
S-percent
Myron
B. Slovin and Marie
Elizabeth
Sushka
general, difficult to quantify. One possibility is that the quantity of commercial loans can serve as a proxy for the provision of such services and thus the need for corporations to maintain compensating balances. When such a commercial loan variable is added to the basic specification, however, the empirical results are poor as can be seen by examining the coefficients reported in Equation (5) in Table 1. This implies that the volume of such loans has little influence on corporate money demand. A third alternative explanation for the poor behavior of the corporate demand for money is that it may be attributed to the expansion of trade credit during recent decades. More specifically, growth in trade credit may serve to reduce the optimal level of balances which firms must maintain on average in order to finance their transactions. When the volume of trade credit is added as an additional variable to the specification for the corporate demand for money, however, it has little statistical effect, as can be seen by examining the pattern of coefficients reported in Equation (6) of Table 1.
2. Structural Instability in the Corporate Sector It is possible that there are important measurement errors in the breakdown of ownership of money balances among the various holders. Nevertheless, this does not seem a likely explanation for the poor corporate results. First, since the data collected for the flow of funds reflect direct corporate reporting, it is the corporate data which are likely to be the most accurate, especially since household data are mainly obtained as residuals to other sectors’ reporting. Second, if errors in apportioning funds among the various sectors were responsible for the poor corporate results, it would be unlikely that we would obtain results for all of the remaining sectors that are so consistent with the implications of an inventory model of money demand. In order to provide some insight into the question of when the deterioration in the behavior of the corporate demand for money occurred, we reestimated the equation for corporate balances over three separate subperiods: 1955-1962, 1963-1968, and 1969-1973. It should be noted that these periods still lie within the time span prior to I974 so they cover a period that Goldfeld would agree is relatively normal. The choice of these subperiods reflects several considerations. The subperiod 1955-1962 covers a calm period in financial markets that is prior to the growth of the negotiable cer366
Demand
for
Money,
Corporate
Sector
tificate of deposit (CDs) market. Furthermore, previous evidence [Slovin and Sushka (1975)] is consistent with a structural shift in money-demand behavior at that time. The years 1963-1968 cover a period which witnessed the development and the substantial growth of corporate cash management techniques and the emergence of a new and growing open market asset, CDs, yet at the same time general money-market conditions were relatively calm. The subperiod after 1968, however, was one of much higher and more volatile interest rates. The estimation results for the regressions representing each subperiod are reported as Equations (l), (2), and (3) of Table 2. The evidence from these regressions indicates that corporate demand for money deteriorated earlier than 1973. More specifically, the specification provides a relatively good description of the period of the 1950s and early 1960s. The regression for the sample period 1955-1962, Equation (l), indicates that both the transactions variable, real business product, and the commercial paper rate (RCP) have the correct signs and are significant, although the implied speed of adjustment per quarter is a slow 7 percent. The R2 is high and the standard error low, although the implied long run elasticity of money with respect to business product, eNBp, appears unrealistically high, but this can be attributed to the implausibly slow speed of adjustment for which we have no a priori explanation. Equation (2) estimated over the period 1962-1968 produces somewhat different results although this period can be viewed as relatively calm without the kind of serious disruptions in the financial market which have occurred periodically since 1968. Each of the variables has the correct sign but neither the transactions variable nor the commercial paper rate is significant. Moreover, there is a substantial increase in the speed of adjustment to 37 percent per quarter and a substantial decrease in the long run elasticity of business product (eNBr) to a more reasonable 0.9. The implied interest rate elasticity (eR) remains high at about 0.42. The R2 is relatively low and the standard error relatively high. Furthermore, the calculation of the F-statistic indicates that we can reject, at the 5percent level of significance, the hypothesis that the 1963-1968 is drawn from the same population as the pre-1963 period.7 This suggests that the corporate demand for money began to shift earlier than 1973. The estimation results obtained by applying this speci-
level
‘The calculated is 2.25.
F is 2.84
while
the
relevant
tabular
value
of F at the
5-percent
367
Myron
B. Slovin and Marie Elizabeth
TABLE 2. Corporate Equation 1
Sample Period 1955-1962
Money-Demand
Lagged Money 0.9294 (11.07)**
2 3 4
5 6 7 8
1963-1968 1969-1973 1955-1968 1969-1973 1969-1976 1969-1976 1969-1976
RCP
Sushka Equations’ Nonfarm Business Product
-0.0446
0.1556
(-3.04)**
(3.01)**
0.6273
-0.1560
0.3321
(3.45)**
(-1.53)
(1.54)
0.1930
0.0322
-0.4838
(0.66)
(0.93)
(-2.24)**
0.7432
-0.0451
0.0634
(9.13)**
(-2.44)**
(2.09)**
0.1857
-0.4764
(0.66)
(-2.07)**
0.5419
0.0116
-0.3272
(3.40)**
(0.55)
(-2.59)**
FGNP
0.2574
-0.0153
0.4671
-0.9231
(1.86)*
(-1.10)
(2.32)**
(-4.20)**
REB
0.2803
0.4741
-0.9137
-0.0198
(2.14)**
(2.47)**
(-4.40)**
(-1.40)
“Primary sources for all data series: Federal Reserve data bank for FMP model, **significant at the five-percent level; *significant at the ten-percent level. be = long term elasticities; NBP subscript indicates nonfarm business product; 52, S3, S4 are quarterly seasonals.
fication over the combined period 1955-1968 are reported as Equation (4) in Table 2 and, although sensible, do not closely resemble the results obtained for either subperiod. Each variable is significant with the correct sign, and the speed of adjustment is a reasonable 26 percent per quarter but the long run elasticities of business product (eNBP)and interest rates (es) are much lower than for either subperiod taken separately. Thus, although the evidence suggests that the corporate demand for money shifted during the 196Os, it did so in a manner that seems reasonable and consistent with the growth of more effective cash management, as predicted by the inventory model. In particular, the degree of interest elasticity rose sharply as did the speed of adjustment to magnitudes that are probably more realistic than the estimates obtained for the period of the 1950s. The estimation results deteriorate considerably, however, for the third subset of observations, 1969-1973, in a way that appears 368
Demand
b
b eNBP
2.204 0.891 -0.600 0.364
S2”
eR
-0.632 -0.419 0.040 -0.176
-0.585 -0.714
0.025
0.628
-0.021
0.659
-0.028
Federal R subscript
Reserve indicates
for
S3”
0.1304
0.1067
(8.30)**
0.1114
(9.27)** 0.0801
(3.70)**
(3.40)**
0.0173 (0.57) 0.0156
0.0376 (1.19)
0.0353
(0.51)
(1.14)
Money,
Corporate
Constunt
s4
0.1666 -0.6119 (12.17)**
(-0.86)
Sector
R2 SE
DW Rho
0.8739
1.96
0.0209
-0.30
2.07 -0.08 1.41 0.24 2.07 -0.26 1.50 0.35
0.1790
0.1744
0.7434
(7.12)**
(0.11)
0.0293
0.0834
8.1052
0.7438
(3.31)**
(2.63)**
0.0284
0.0823
1.0857
0.7753
(3.26)**
(2.04)**
0.0276
0.0880 (3.89)**
8.1584 (2.65)**
0.7062 0.0304
0.0205 0.0437 (0.73) (1.62) 0.0625 0.0699 (2.99)** (3.67)** 0.0326 0.0468 (1.75)* (3.01)** 0.0353 0.0502
0.1117
4.9688
0.7860
(6.13)**
(2.87)**
0.0307
-0.50
0.0978 (6.37)**
5.5942 (4.43)**
0.8722 0.0237
0.1002
5.3679
0.8752
(1.89)*
(6.43)**
(4.47)**
0.0235
2.02 -0.18 2.03 -0.22
Flow
of the
(3.34)** Funds
relevant
data interest
bank.
The
t-statistics
are
in
1.92
parenthesis;
rate.
difficult to rationalize. Neither the commercial paper rate nor business product have the correct sign and the coefficient of the constant rises dramatically as reported in Equation (3). In fact, real business product has a coefficient of -0.48 and is statistically significant, an especially disturbing result. Even when the commercial paper rate is excluded, business product still obtains the wrong sign as illustrated by the results in Equation (5). Again, an F-test for structural stability rejects the hypothesis that this third subperiod is drawn from the same population as either the 1958-1962 or the longer 1958-1968 period.’ When the specification is estimated over the sample period 1969-1976, the pattern of the estimated coefficients remains the same as reported in Equation (6), with the transactions variable still negative and significant. Moreover, the ‘The calculated tabular values of
values of F are F at the S-percent
3.26 and 4.15, respectively, level are 2.26 and 2.14.
while
the
relevant
Myron
B. Slovin and Marie Elizabeth
Sushka
results obtained from an F-test for structural stability again suggest that there is no evidence that the period 1974-1976 is drawn from a population different from that of 1969-1973.’ In general, since the subperiod estimation results differ so much between the three periods, it is not surprising that the full-period estimation results are so poor for the corporate sector. Thus, the empirical results suggest that the narrowly defined corporate sector’s demand for money balances has not been stable and that its behavior during the 1970s cannot be easily rationalized on the basis of the inventory theory of money demand that is so commonly and routinely applied in aggregate demand for money studies.
3. International
Components
of Corporate
Money
Demand
These results for the corporate sector are disturbing since many financial economists generally presume that the corporate sector is conscious of optimizing cash balances and suggest that some important element of the economic environment of the 1970s must be missing from the standard money-demand specification. Our hypothesis is that this missing element may be international influences. Most large American corporations are international in scope and, given the degree of integration that pervades the international economy, the distribution of corporate cash holdings between domestic banks and those abroad may be sensitive to the relative levels of economic activity at home and abroad. In order to test this hypothesis, an index of foreign income (FGNP) is added to specification and the results are reported in Equation (7) of Table 2.” The foreign GNP variable is negative and significant as expected, with a t-statistic in excess of 4. Moreover, the coefficient of domestic business product changes sign and becomes significantly positive. In addition, there is a dramatic reduction in the standard error of the regression by about 20 percent and a concomitant rise in the R2. Although the coefficient of the commercial paper rate is not significant, it becomes negative. When the Eurodollar deposit rate (REB) is substituted for the domestic commercial paper rate, Equation (8), the results are somewhat better. Although this inter‘The calculated value of F is 1.35 while the relevant tabular value of F at the 5-percent level is 2.69. “‘This series is a weighted average of real GNP for the following countries, where the weights are the bilateral trade shares: Canada, Germany, Japan, United Kingdom, France, Italy, Netherlands, Belgium, Sweden, and Switzerland.
370
Demand
for Money,
Corporate
Sector
est rate variable is still not significant, the size and sign of the interest elasticity (es) is reasonable. l1 These results imply that although corporations optimize cash balances in a manner predicted by the inventory model, because their transactions and their cash are held worldwide, domestic holdings of cash by corporations are sensitive to economic activity abroad. Thus, the evidence indicates that the integration of economic activity across international borders may have become an important factor in explaining financial behavior at American corporations.
4. Conclusion Overall, although the power of the inventory-theoretic approach is impressive with respect to its ability to describe the demand for money held in the economy outside of the corporate sector, the behavior of the demand for money on the part of the corporate sector seems much less susceptible to analysis using the standard specification of the inventory model. The problem, however, is not the inability of a corporate equation to explain the 19741976 period; rather, that the simple inventory model does not imply stability in the corporate demand for money over the 1950s and the 1960s and does not appear applicable to the 1970s. The apparent explanation for the difficulties with such equations for the 1970s appears to be related to the omission of the influence of the level of foreign economic activity on the domestic holdings of cash by the corporate sector. Received: June 1981 Final oersion received:
November
1982
References Goldfeld, S. “The Case of the Missing Money.” Brookings Papers on Economic Activity 3 (1976): 683-740. -. “The Demand for Money Revisited. ” Brookings Papers on Economic Activity 3 (1973): 557-638. Judd, J. and J. &adding. “The Search for a Stable Money Demand
“Essentially identical results are obtained for rate. Because of the presence of multicollinearity, tained whenever attempts were made to include specification.
the CD rate or the federal funds poor estimation results were obtwo interest rate variables in the
371
Myron
B. Slovin and Marie
Elizabeth
Sushka
Function: A Survey of the Post-1973 Literature.” Journal of Economic Literature (September 1982): 993-1023. Laidler, D. The Demand for Money: Theories and Evidence. Scranton: International Textbook Company, 1977. Modigliani, F., R. Rasche, and J. Cooper. “Central Bank Policy, the Money Supply and the Short Term Rate of Interest. ” Journal of Money, Credit, and Banking (May 1970): 166-218. Slovin, M. and M. Sushka. “The Structural Shift in the Demand for Money. ” Journal of Finance (June 1975): 721-31. Sprenkle, C. Effects of Large Firm and Bank Behavior on the Demand for Money of Large Firms. Washington, D.C.: American Bankers Association, 1971.
372