Divisia Monetary Aggregates, the Great Ratios, and Classical Money Demand Functions
01 Feb 2014-Journal of Money, Credit and Banking (John Wiley & Sons, Ltd (10.1111))-Vol. 46, Iss: 1, pp 229-241
TL;DR: The authors revisited the cointegration tests in the spirit of King et al. and showed that previous rejections of the balanced growth hypothesis and classical money demand functions can be attributed to mismasurement of the monetary aggregates.
Abstract: King et al. (1991) evaluate the empirical relevance of a class of real business cycle models with permanent productivity shocks by analyzing the stochastic trend properties of postwar U.S. macroeconomic data. They find a common stochastic trend in a three-variable system that includes output, consumption, and investment, but the explanatory power of the common trend drops significantly when they add money balances and the nominal interest rate. In this paper, we revisit the cointegration tests in the spirit of King et al., using improved monetary aggregates whose construction has been stimulated by the Barnett critique. We show that previous rejections of the balanced growth hypothesis and classical money demand functions can be attributed to mismeasurement of the monetary aggregates.
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TL;DR: In this article, the authors revisited the questions on monetary policy, exchange rate delayed overshooting, the inflationary puzzle, and the weak monetary transmission mechanism for the open Indian economy and further incorporated a superior monetary measure, the aggregation-theoretic Divisia monetary aggregate.
Abstract: Following the exchange-rate paper by Kim and Roubini (J Monet Econ 45(3):561–586, 2000), we revisit the questions on monetary policy, exchange rate delayed overshooting, the inflationary puzzle, and the weak monetary transmission mechanism; but we do so for the open Indian economy. We further incorporate a superior monetary measure, the aggregation-theoretic Divisia monetary aggregate. Our paper confirms the efficacy of the Kim and Roubini (J Monet Econ 45(3):561–586, 2000) contemporaneous restriction, customized for the Indian economy, especially when compared with recursive structure, which is damaged by the price puzzle and the exchange rate puzzle. The importance of incorporating correctly measured money into the exchange rate model is illustrated, when we compare models with no-money, simple-sum monetary measures, and Divisia monetary measures. Our results are confirmed in terms of impulse response, variance decomposition analysis, and out-of-sample forecasting. In addition, we do a flip-flop variance decomposition analysis, finding two important phenomena in the Indian economy: (i) the existence of a weak link between the nominal-policy variable and real-economic activity, and (ii) the use of inflation-targeting as a primary goal of the Indian monetary authority. These two main results are robust, holding across different time period, dissimilar monetary aggregates, and diverse exogenous model designs.
41 citations
TL;DR: In this article, the authors used a highly disaggregated demand system to estimate the degree of substitutability among monetary assets and to address the issue of optimal monetary aggregation in the United States.
Abstract: This paper uses a highly disaggregated demand system to estimate the degree of substitutability among monetary assets and to address the issue of optimal monetary aggregation in the United States. We address the problems of dimensionality and nonlinearity, estimating a very detailed monetary asset demand system encompassing the full range of assets based on the locally flexible normalized quadratic expenditure function. We treat the concavity property as a maintained hypothesis and provide evidence consistent with neoclassical microeconomic theory. Statistical tests reject the appropriateness of the aggregation assumptions for all the money measures published by the Federal Reserve as well as for a large number of groupings suggested by earlier studies. This supports and reinforces Barnett's (2016) assertion that we should employ the broadest M4 monetary aggregate published by the Center for Financial Stability.
35 citations
Cites background from "Divisia Monetary Aggregates, the Gr..."
...…performance of the Divisia monetary aggregates has been demonstrated by a large number of studies, more recently by Barnett and Chauvet (2011), Serletis and Gogas (2014), Hendrickson (2014), Belongia and Ireland (2014, 2015a, 2015b), Serletis and Istiak (2016), and Serletis and Koustas…...
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TL;DR: The authors explored the relationship between Friedman's work and the work on Divisia monetary aggregation, originated by William A. Barnett, and concluded that monetary policy becomes relevant to monetary policy in all macroeconomic traditions, including New Keynesian economics, real business cycle theory, and monetarist economomics.
Abstract: This paper explores the relationship between Milton Friedman’s work and the work on Divisia monetary aggregation, originated by William A. Barnett. The paradoxes associated with Milton Friedman’s work are largely resolved by replacing the official simple-sum monetary aggregates with monetary aggregates consistent with economic index number theory, such as Divisia monetary aggregates. Demand function stability becomes no more of a problem for money than for any other good or service. Money becomes relevant to monetary policy in all macroeconomic traditions, including New Keynesian economics, real business cycle theory, and monetarist economomics.
Research and data on Divisia monetary aggregates are available for over 40 countries throughout the world from the online library within the Center for Financial Stability’s (CFS) program, Advances in Monetary and Financial Measurement. This paper supports adopting the standards of monetary data competency advocated by the CFS and the International Monetary Fund (2008, pp. 183-184).
34 citations
Cites background from "Divisia Monetary Aggregates, the Gr..."
...…monetary targeting will find support for Divisia monetary targeting in Serletis and Rahman (2013).22 Divisia monetary aggregates are not only relevant to New Keynesian models, but more relevant than commonly believed to classical real business cycle models, as found by Serletis and Gogas (2014)....
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...…Fund 23 An overview of much of that literature can be found in Barnett (2012), Barnett and Binner (2004), Barnett and Chauvet (2011a,b), Barnett and Serletis (2000), Belongia (1996), Belongia and Ireland (2003a,b,c), Serletis (2007), Serletis and Gogas (2014), and Serletis and Shahmoradi (2006)....
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References
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TL;DR: The relationship between co-integration and error correction models, first suggested in Granger (1981), is here extended and used to develop estimation procedures, tests, and empirical examples.
Abstract: The relationship between co-integration and error correction models, first suggested in Granger (1981), is here extended and used to develop estimation procedures, tests, and empirical examples. If each element of a vector of time series x first achieves stationarity after differencing, but a linear combination a'x is already stationary, the time series x are said to be co-integrated with co-integrating vector a. There may be several such co-integrating vectors so that a becomes a matrix. Interpreting a'x,= 0 as a long run equilibrium, co-integration implies that deviations from equilibrium are stationary, with finite variance, even though the series themselves are nonstationary and have infinite variance. The paper presents a representation theorem based on Granger (1983), which connects the moving average, autoregressive, and error correction representations for co-integrated systems. A vector autoregression in differenced variables is incompatible with these representations. Estimation of these models is discussed and a simple but asymptotically efficient two-step estimator is proposed. Testing for co-integration combines the problems of unit root tests and tests with parameters unidentified under the null. Seven statistics are formulated and analyzed. The critical values of these statistics are calculated based on a Monte Carlo simulation. Using these critical values, the power properties of the tests are examined and one test procedure is recommended for application. In a series of examples it is found that consumption and income are co-integrated, wages and prices are not, short and long interest rates are, and nominal GNP is co-integrated with M2, but not M1, M3, or aggregate liquid assets.
27,170 citations
TL;DR: In this paper, the authors consider a nonstationary vector autoregressive process which is integrated of order 1, and generated by i.i.d. Gaussian errors, and derive the maximum likelihood estimator of the space of cointegration vectors and the likelihood ratio test of the hypothesis that it has a given number of dimensions.
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"Divisia Monetary Aggregates, the Gr..." refers methods in this paper
...In this section, we apply the Johansen (1988) maximum likelihood approach for estimating long-run equilibrium relations in multivariate vector autoregressive models....
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13,292 citations
"Divisia Monetary Aggregates, the Gr..." refers methods in this paper
...Moreover, based on augmented Dickey and Fuller (1981) tests, Kwiatkowski et al. (1992) trend stationarity tests, and Elliot et al. (1996) point optimal tests, we nd that all series are I(1)....
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TL;DR: In this paper, a test of the null hypothesis that an observable series is stationary around a deterministic trend is proposed, where the series is expressed as the sum of deterministic trends, random walks, and stationary error.
10,068 citations
"Divisia Monetary Aggregates, the Gr..." refers methods in this paper
...Moreover, based on augmented Dickey and Fuller (1981) tests, Kwiatkowski et al. (1992) trend stationarity tests, and Elliot et al. (1996) point optimal tests, we nd that all series are I(1)....
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TL;DR: In this paper, a modified version of the Dickey-Fuller t test is proposed to improve the power when an unknown mean or trend is present, and a Monte Carlo experiment indicates that the modified test works well in small samples.
Abstract: The asymptotic power envelope is derived for point-optimal tests of a unit root in the autoregressive representation of a Gaussian time series under various trend specifications. We propose a family of tests whose asymptotic power functions are tangent to the power envelope at one point and are never far below the envelope. When the series has no deterministic component, some previously proposed tests are shown to be asymptotically equivalent to members of this family. When the series has an unknown mean or linear trend, commonly used tests are found to be dominated by members of the family of point-optimal invariant tests. We propose a modified version of the Dickey-Fuller t test which has substantially improved power when an unknown mean or trend is present. A Monte Carlo experiment indicates that the modified test works well in small samples.
4,284 citations