Working paper No. 100
By Andrew Brigden and and Paul Mizen
This paper considers the interactions between gross domestic fixed capital formation, an important component of domestic demand, and the real money and credit balances of private non-financial corporations. It is acknowledged that banks and firms both have incentives to form special relationships, and that this may lead to important lines of transmission between credit, money and real activity. Our approach is to use the systems approach of Hendry and Mizon (1993) to model the three variables jointly.
We find long-run equilibrium relationships which confirm that real decisions are important to the financial structure of firms, and that departures from long-run equilibria in money and credit feedback to investment. Evidence of a direct credit channel comes from these causal chains. A further indirect channel operates through the dynamics as the lending spread over Libor feeds through to changes in investment. Together these support the case for a credit channel and indicate that money, credit and investment should be modelled as a system.
Money, credit and investment in the UK corporate sector