AN EMPIRICAL STUDY OF FINANCIAL INTERMEDIATION IN CANADA.

Considerable attention bas been focused in the past two decades on the substitutability of the liabilities of private nonmonetary financial intermediaries for money, narrowly defined as the sum of currency and demand deposits adjusted. Discussion concerning this topic related to the United States, and most of the empirical work has been confined to that country. The essential folklore of that discussion crossed the border into Canada and is now even reflected in its textbooks on Canadian money and banking. However, very little empirical work has been done in Canada to examine this lore. This paper examines the substitutability for money of three nonmonetary assets over the period 1946-1967: (1) notice deposits in chartered banks, (2) deposits in trust companies,and (3) deposits in mortgage loan companies. Section I, assuming functional separability of liquid and riskless financial assets in a utility function over all goods, estimates a liquidity preference function for Canada. This method, followed by Cherty [2] and Hands [10], directly estimates the elasticities of substitution between money and near-money assets. These elasticities are estimated for the transactions approach to the demand for money in the first part of Section I and for the portfolio approach in the remaining part of the section. Estimates show a zero elasticity of substitution between the assets for both approaches. Although this is undoubtedly the most satisfactory theoretical approach to follow, the results contradict those for the United States, as shown in Chetty and Hands, as well as institutional practice in constructing money supply indices for Canada. This contradiction might be due to defective data on the rates of return on the assets. Section II then explores another method which avoids using these rates of return. It uses the canonical correlation technique to find the degree of moneyness or liquidity of the nonmonetary assets. This indicates that deposits in trust companies and... [ABSTRACT FROM AUTHOR]