The British Banking System's Demand for Cash Reserves

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Abstract
There has been considerable controbersy in the United Kingdom about the most appropriate method of conducting monetary policy. This controversy has focused on the concept of the montary base and its present and potiential usefulness as an instrument of monetary policy. This paper is intended to help resolve this controversy by analyzying an important part of the monetary system in existence in the United Kingdow during the years 1973-1978 and referred to as the "present" system in this paper. First, a brief description of the relevant aspects of the British monetary system is presented. Next, a theoretical model of the banking system's demand for cash reserves (i.e., vault cash plus cash deposits as the Bank of England_ is developed. This models is estimated and conclusions are drawn based on the empirical results. It is found that in the present British monetary system, banks' demand for cash reserves is a well-defined and well-behaved function of bank deposit liabtilities and a few other observable variables. Thus a policy of achieving monetary growth targets by means of conventional open-market operations by the Bank of England -- that is, by manipulating the supply of monetary base -- appears to eb beasible under present circumstances, asuming that the demand for the montary base by nonbanks is also well defined.

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