A Comprehensive Revision of the US Monetary Services (Divisia) Indexes
Summary (5 min read)
Introduction
- The authors introduce a comprehensive revision of the Divisia monetary aggregates for the United States published by the Federal Reserve Bank of St. Louis, referred to as the Monetary Services Indexes (MSI).
- Several aspects of the new MSI differ from those previously published.
- Some assets, including currency and checkable bank deposits, are innately medium of exchange—that is, usable in the purchase and sale of goods and services— while others cannot be used until converted to medium of exchange.
- Abstracts, synopses, and other derivative works may be made only with prior written permission of the Federal Reserve Bank of St. Louis.
THE MACROECONOMICS OF MONETARY AGGREGATION
- This article discusses how to construct monetary index numbers (Divisia monetary aggregates) for the United States.
- A complementary, but alternative, line of thought argues that (i) the concept of a monetary aggregate in macroeconomics is unnecessary and misleading and (ii) models should focus on the functions of financial assets, including as a medium of exchange and an intertemporal store of value.
- LOUIS REVIEW 2 Throughout this analysis, the term “monetary assets” refers to those financial assets that can provide “monetary services” during the period—that is, they can serve as a medium of exchange.
- In such models, most financial assets are treated as near-perfect substitutes; the role of the transaction costs entailed in exchanging an asset that does not furnish medium of exchange services for one that does is secondary, such that even mortgage-backed securities furnish medium of exchange (that is, monetary) services.
THE ROLE OF THE FEDERAL RESERVE BANK OF ST. LOUIS
- The Federal Reserve Bank of St. Louis has published monetary index numbers (initially referred to as Divisia monetary aggregates and, later, as Monetary Services Indexes [MSI]) for two decades, beginning with Thornton and Yue (1992) and continuing with Anderson, Jones, and Nesmith (1997a,b,c) and Anderson and Buol (2005).
- MSI-ALL is constructed over all assets currently reported on the Federal Reserve Board’s H.6 statistical release (the components of M2 plus institutional money market mutual funds [MMMFs]) and is the broadest level of aggregation that currently can be constructed from available data.
- The authors also improved measures of savings and small time deposit rates in the Regulation Q era; as a consequence, the start date of the MSI has been changed from 1960 to 1967.
- The alternative benchmark rate is the larger of their preferred benchmark rate and the Baa bond yield.
- The next section provides a brief over - FEDERAL RESERVE BANK OF ST.
MONETARY AGGREGATION AND INDEX NUMBER THEORY
- This section briefly reviews the economic theory of monetary aggregation.
- Readers interested primarily in the data may skip this section without loss of continuity; readers seeking a more comprehensive survey might consult Anderson, Jones, and Nesmith (1997b).
- The user cost of a monetary asset, defined as the interest income forgone by holding a specific financial asset rather than a higher-yielding asset that does not provide monetary services, plays an essential role in monetary aggregation theory.
- Divisia monetary aggregates are chain-weighted superlative indexes constructed over the quantities and user costs of selected sets of monetary assets.
- The earliest Divisia aggregates for the United States were constructed at the Federal Reserve Board through the mid-1980s by Barnett, Offenbacher, and Spindt (1981) and, later, by Farr and Johnson (1985), who introduced the descriptive label “Monetary Services Indexes.”.
Background
- Barnett (1978, 1980) developed Divisia monetary aggregates from aggregation and index number theory; see Barnett and Serletis (2000) for a comprehensive overview.
- When optimizing in period t, currentperiod real money balances, mn,t, are multiplied in the lifetime budget constraint by πn,t = p*t un,t, where Consequently, πn,t is the user cost for mn,t.7 Usually, πn,t is referred to as the “nominal user cost” and un,t as the corresponding “real user cost” (Barnett, 1987, p. 118).
- In an alternative derivation, Donovan (1978, pp. 682-86) obtained the same expression by applying the user cost formula for a durable good to interest-bearing monetary assets.
- In the present context, monetary assets are weakly separable from the other goods and services included in the utility function if where U is strictly increasing in V (see Varian, 1983, p. 104).
- Specifi - cally, the MSI are based on the superlative Törnqvist-Theil formula.
The MSI and Their Dual User Cost Indexes
- The published St. Louis MSI are constructed from nominal rather than real monetary asset quantities and, in that sense, are nominal monetary index numbers; corresponding real MSI can be obtained by dividing the nominal MSI by a price index.
- The real user cost indexes can be multiplied by a price index to obtain corresponding nominal user cost indexes.
- Thus, the purchase price of a real dollar of the monetary asset is p*t and the sale price of a real dollar of the asset one period later is p*t+1.
- A number of studies have applied tests of these conditions to determine if specific groupings of monetary assets are weakly separable.
MSI p
- Not exclusively, on aspects of the MSI that differ substantively from their earlier work (Anderson, Jones, and Nesmith, 1997c).
- The authors caution readers that this section is necessarily detail oriented, but understanding the details, though sometimes tedious, is essential if the MSI are to be used intelligently in economic research and policymaking.
Aggregation Levels, Components, and Segments
- The revised St. Louis MSI introduced in this article are monthly data beginning in January 1967; when this paper was written, the most recent available data were for May 2011.
- More specifically, MSI-M2M is defined over the components of MSI-M2 except small-denomination time deposits, and MSI-MZM is defined over the components of MSI-M2M plus institutional MMMFs (equivalently, it includes all components of MSIALL except small-denomination time deposits).
- Readers should note that the number of components included in the MSI varies from month to month due to data availability.
- Exam - ples of newly available data that increased the number of components include retail MMMFs (February 1973), institutional MMMFs (January 1974), other checkable deposits (OCDs) at com- 330 SEPTEMBER/OCTOBER 2011 FEDERAL RESERVE BANK OF ST.
- This follows from the fact that the expenditure shares add up to 1.
Retail Sweep Adjustment
- Retail sweep programs at depository institutions began in January 1994.
- Growth of M1 deposits has been depressed for a number of years by these programs, which shift—or ‘‘sweep’’— balances from household transactions accounts, which are subject to reserve requirements, into savings accounts, which are not.
- Nevertheless, Federal Reserve Board staff estimate the amounts each month, and their estimates are available publicly on the St. Louis Fed’s website.
- 16 Figure 2 plots MSI-M1 against a comparable index constructed over components not adjusted for retail sweeping; failing to adjust for the effects of retail sweeps causes significant understatement of MSI-M1.17 14 See http://research.stlouisfed.org/aggreg/swdata.html.
- Measurement of the benchmark rate is addressed in the next section.
Benchmark Rates
- The theory of monetary aggregation assumes that there exists a benchmark asset that furnishes no monetary services—that is, an asset that is used only to transfer wealth from period to period.
- Long-term bond yields are often used as benchmark rates, but this approach is somewhat problematic….
- The authors construct MSI using a benchmark rate equal to the upper envelope plus a constant (that is, not time-varying) liquidity premium of 100 basis points, which they refer to as their “preferred” benchmark rate.
- On the other hand, adding just 152 basis points (rather than 200 basis points) to the 6-month Treasury bill rate is sufficient to produce a benchmark rate that exceeds the upper envelope in all but two months over this period.
- Figure 3 compares year-over-year growth rates for MSI-ALL using the two benchmark rates.
Own Rates of Return
- The MSI require estimates of the user costs of each component, which are derived from the spread between the benchmark rate of return and the component’s own rate of return.
- The prohibition of interest on demand deposits distorts the pricing of transaction deposits and associated bank services.
- Available data include monthly figures for deposit own rates published between 1983 and 1997 by the Federal Reserve Board in a supplementary table (Monthly Survey of Selected Deposits [FR2042]) to the H.6 statistical release.
- In 1957 and 1962, when market interest rates rose near or above the ceiling rates on savings deposits, these ceilings were raised….
- For January 1967 –May 1978, the authors set the own rate for smalldenomination time deposits at thrift institutions equal to the own rate on deposits at commercial banks plus the difference between the corre - sponding interest rate ceilings.
Long-Run and Short-Run Growth
- Figure 8 shows both month-to-month and year-over-year MSI growth.
- Generally speaking, movements in the five MSI are similar.
- Figure 9 depicts growth of MSI during four selected decade-long periods.
- MSI growth slowed during 1969 as Federal Open Market Committee (FOMC) policy tightened, with decreases during 1970 in the levels of MSI-M2M and MSI-MZM.
- Panel D includes the 2001 recession/recovery, the subsequent housing boom and financial crisis, and the Federal Reserve’s credit-easing policies during 2008 and its 2009-11 quantitative easing policies.
Method of Aggregation Versus Scope of the Aggregate
- This section compares and contrasts the MSI with each other and monetary aggregates constructed by summation of the dollar amounts of the included assets; the latter are denoted as “SUM-M1” and so on.
- SUM-M2M, SUM-MZM, and SUM-M2 are identical to the monetary aggregates available through FRED.31 SUM-M1 is not the same as the Federal Reserve’s M1 aggregate because it is retail-sweep adjusted to be comparable with MSI-M1.32 SUM-ALL is identical to SUM-M2 plus institutional MMMFs, which are also available through FRED.
- With respect to the former, monetary aggregates produced by the Federal Reserve’s Board of Governors are summation aggregates:.
- From the standpoint of monetary aggregation/index number theory, the two issues are related since superlative index numbers should be constructed over groups of monetary assets that are weakly separable.
- Figure 10 shows a scatterplot matrix of monthto-month percentage growth rates of the five MSI; correlations between the MSI are shown in the 346 SEPTEMBER/OCTOBER 2011 FEDERAL RESERVE BANK OF ST.
SUMMARY AND CONCLUSIONS
- Valuable resources to empirical economists interested in the role that money plays in the economy.
- The authors also introduce a new benchmark rate, defined as the largest rate in a set of rates that includes the own rates of the components of the broadest index and yields on selected short-term money market rates (the upper envelope) plus a modest liquidity premium.
- A major problem with the official M1 monetary aggregate is, of course, retail sweeping of transaction deposits.
- As Lucas (2000, pp. 270-71) has argued, “I share the widely held opinion that M1 is too narrow an aggregate for this period [the 1990s], and I think that the Divisia approach offers much the best pros pects for resolving the difficulty.”.
- On the other hand, growth rates of MSI-M2 and MSI-ALL diverged much more than usual in 2010, suggesting that MSI-M3 might have contained some additional information in recent years.
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Cites background or methods from "A Comprehensive Revision of the US ..."
...See Anderson and Jones (2011). But since the Federal Reserve no longer provides its former broad aggregates, M3 and L, the CFS is now maintaining the broad aggregates, Divisia M3 and Divisia M4, where M4 is similar to the Fed’s former broadest aggregate, L....
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...We acquired that interest rate from the MSI component spreadsheet provided to us by Richard Anderson for the paper Anderson and Jones (2011). After 1987 the rate or return on interest-bearing checking accounts is from the Bank Rate Monitor Survey....
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...Louis Fed for the paper, Anderson and Jones (2011). From 1986 to 1991, that data set is also used to acquire the average monthly interest-rate paid on savings deposits....
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...Anderson and Jones (2011) and Anderson, Jones, and Nesmith (1997) investigated the possibility of assigning a non-zero own rate to demand deposits and proposed alternative methods, originally suggested by Barnett and Spindt (1982), Farr and Johnson (1985), and Thornton and Yue (1992). In these imputation procedures, household and business demand-deposits are separated....
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...We acquired that interest rate from the MSI component spreadsheet provided to us by Richard Anderson for the paper Anderson and Jones (2011)....
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72 citations
Cites methods from "A Comprehensive Revision of the US ..."
...It is to be noted that in this paper we do not report evidence using the St. Louis Fed s Divisia monetary aggregates, called MSI (monetary services indices), the new vintage of which is documented in Anderson and Jones (2011)....
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...In particular, J-B is the Jarque-Bera (1980) test statistic distributed as a (2)(2) under the null hypothesis of normality and LM is a multivariate test statistic distributed as a 2 with K(2) degrees of freedom (where K is the number of endogenous variables in the VAR) under the null hypothesis of no serial correlation....
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References
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"A Comprehensive Revision of the US ..." refers background in this paper
...For further discussion of retail sweeping, see Anderson (1995), Anderson and Rasche (2001), Dutkowsky and Cynamon (2003), Duca and VanHoose (2004), Jones, Dutkowsky, and Elger (2005), Dutkowsky, Cynamon, and Jones (2006), Elger, Jones, and Nilsson (2006), and Jones et al. (2008)....
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103 citations