"Differential Cash Constraints, Financial Leverage and the Demand for Money: Evidence from a Complete Panel of Taiwanese Firms", Journal of Macroeconomics, 30, 523-542, 2008(with Meng-Wen Tsou and Ping Wang), (SSCI)

In order to make effective monetary policy, it is essential to understand demand for money. This paper makes two contributions to the literature on the money demand of firms. First, we develop a new model based on a differential cash-in-advance constraint. In short, we make the plausible assumption that wage bills must be fully paid in cash while investment goods may be partially purchased on credit. At steady state, the model implies that money demand will be positively correlated with wage bills, investment, and profitability and negatively correlated with the firm’s leverage ratio as well as the inflation and money growth rates. Our second contribution is to test these hypotheses with actual Taiwanese panel data from the period 1990-1997. Our predictions are verified and robust to several different specifications including the use of instrumental variables. Furthermore, the large coefficients on wage bills and the small coefficients on investment in our empirical analysis lend support to the existence of a differential cash-in-advance constraint similar to the one specified in our model. We also find that Taiwanese firms exhibit economies of scale in money demand, with larger firms requiring proportionately less money to operate relative to smaller firms. While it should be noted that our research only considers firm-level money demand, there are still several implications regarding monetary policy. First, the presence of economies of scale implies that relatively large Taiwanese firms have little need for liquidity. Secondly, in light of the response of large firms to monetary policy, inflation targeting may be justified. Finally, since money demand depends crucially on leverage, when designing monetary policy it is essential to consider the economy-wide financial position of firms.