The Demand for M4: A Sectoral Analysis. Part 1 - The Personal Sector

Interpreting movements in monetary aggregates is an important part of the assessment of inflationary pressures in the UK's current monetary policy framework. This paper is the first part of a follow-up study to Fisher and Vega in 1993, examining the determinants of personal sector holdings of M4 in the UK and the role they play in the transmission mechanism. A joint-model of personal sector M4 and consumption is developed which offers some useful insights into the role of money in the economy. In the long run both money and consumption are found to be related to income, wealth and interest rates, the estimated relationships being fairly standard theoretical specifications. But the model also reveals that money and consumption interact strongly in the short run, the nature of the interaction depending on the type of disturbance that has occurred. Positive disturbances to consumption initially lead to a fall in money balances, so that there is a negative relationship between money and consumption in the short-run. This is consistent with money's role as a "buffer-stock" which absorbs short-term fluctuations in spending. Positive disturbances to money, on the other hand, lead to a rise in consumption in the first instance, so that the short-run relationship is positive. This would be consistent with a number of possible liquidity and credit effects on consumption. These different relationships have important implications for interpreting movements in personal sector money holdings. Faster money growth may be consistent with a number of different underlying disturbances, each requiring its own policy response.