THE PORTFOLIO BEHAVIOUR OF SELECTED CANADIAN FINANCIAL INTERMEDIARIES: AN ECONOMETRIC ANALYSIS

Abstract

THIS STUDY PRESENTS a quarterly econometric model of the financial sector of the Canadian economy for the period from 1954 to 1967. It is designed to provide some empirical evidence on the adjustment mechanism for the transmission of monetary policy. The model comprises four sectors, namely the chartered bank sector, the trust and mortgage loan companies, the life insurance companies, and a residual private sector. The asset sides of the balance sheets for each of these four sectors include individual demand equations for federal government treasury bills and bonds, municipal and provincial government securities, corporate securities, mortgages, and currency and chartered bank deposit liabilities. The supply equations for corporate securities and federal, provincial, and municipal bonds are exogenously determined. The remaining supply equations, including the deposit liabilities of the chartered banks and trust and mortgage loan companies, are endogenous to the model. The model does not include an endogenous real sector. In total, the model consists of 49 equations, 35 of which are estimated by simultaneous equation techniques, while 14 equations are indentities. The statistical results for the equations in the study, in general, tend to support the hypotheses advanced for the portfolio behaviour of the various financial intermediaries. Also, the many different values of the various coefficients for the Koyck type lagged dependent variables, within the equations of the model, suggest a significant and varied lag structure for the different asset categories. These results lend support to those who maintain the lags in monetary policy are long and varied. The structure of the model enables one to examine the impact of specific monetary policy instruments on the various financial markets and intermediaries. The results of the policy instrument experiments are presented in the form of impact multipliers. The policy instruments examined include open market operations and a change in the Bank Rate. To illustrate the results of the model, consider a $100 million open market sale of government bonds, and a corresponding reduction in high powered money. This amount represented approximately one per cent of the federal government bonds outstanding in 1966. The model indicates that as a result of this sale commercial banks reduce their holdings of government bonds by $271 million and their inventory of treasury bills by approximately $12 million. Correspondingly, the life insurance companies reduce their aggregate holdings of federal government bonds and treasury bills by $1 million, while trust and mortgage loan companies increase their aggregate holdings of these securities by $25 million and the private sector adds $357 million of these securities to their inventories. The sum of these changes, of course, equals the $100 million by which total government securities were increased initially. The large reduction in government bonds in the chartered bank sector is accounted for, in part, by a decrease in their deposit liabilities of approximately $143 million. Consequently, the model suggests that the major initial impact of a federal