Summary of WP/94/118: “Monetary Aggregation: A Reconciliation of Theory and Central Bank Practice”

Authors of Working Papers are normally staff members of the Fund or consultants, although on occasion outside authors may collaborate with a staff member in writing a paper. The views expressed in the Working Papers or their summaries are, however, those of the authors and should not necessarily be interpreted as representing the views of the Fund. Copies of individual Working Papers and information on subscriptions to the annual series of Working Papers may be obtained from IMF Publication Services, International Monetary Fund, 700 19th Street, Washington, D.C. 20431. Telephone: (202) 623-7430 Telefax: (202) 623-7201 This compilation of summaries of Working Papers released during July-December 1994 is being issued as a part of the Working Paper series. It is designed to provide the reader with an overview of the research work performed by the staff during the period.

Abstract

Authors of Working Papers are normally staff members of the Fund or consultants, although on occasion outside authors may collaborate with a staff member in writing a paper. The views expressed in the Working Papers or their summaries are, however, those of the authors and should not necessarily be interpreted as representing the views of the Fund. Copies of individual Working Papers and information on subscriptions to the annual series of Working Papers may be obtained from IMF Publication Services, International Monetary Fund, 700 19th Street, Washington, D.C. 20431. Telephone: (202) 623-7430 Telefax: (202) 623-7201 This compilation of summaries of Working Papers released during July-December 1994 is being issued as a part of the Working Paper series. It is designed to provide the reader with an overview of the research work performed by the staff during the period.

While academic economists have exerted considerable influence over the evolution of many areas of public policy in recent years, this has been far from the case in the field of monetary aggregation. Over the last two decades, academics have consistently advocated the use of weighted aggregates, notably the Divisia Index, that purport to measure the services provided by monetary assets to the depositors who hold them. However, over the same period, central banks have remained wedded to conventional simple-sum aggregates in presenting policy and implementing monetary targets. This paper offers an explanation of why academic economists have failed to influence central bankers’ choice of monetary aggregates.

Weighted monetary aggregates, such as the Divisia Index, attempt to measure the transactions services provided by monetary assets. Implicitly, advocates of such aggregates are assuming that the transactions model of money is the correct specification at a macroeconomic level. However, this not need be the case; there are alternative models of the role of money and the banking system in the macroeconomy that attribute a central role to the aggregate size of the banking system’s balance sheet. This paper suggests that a conventional simple-sum aggregate may provide the appropriate measure of money in such a model.

Identification problems make testing between the alternative structural models essentially impossible in macroeconomic time series. Central bankers--who are primarily interested in the “information content” of monetary data--are content to rely on estimates of reduced-form relationships that reveal the statistical indicator properties of various monetary measures. The paper concludes that until weighted measures perform unambiguously better on such criteria, central bankers may be justified in continuing to use the conventional simple-sum aggregates.

Working Paper Summaries (WP/94/77 - WP/94/147)
Author: International Monetary Fund