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Dmacomb 5..23 Contents List of Figures vii List of Tables ix Notes on the Contributors xii Introductory Comments, De®nitions, and Research on Indexes of Monetary Services Michael T. Belongia 1 Part I New Results in Theory and Practice 1 Beyond the Risk-neutral Utility Function William A. Barnett and Yi Liu 11 2 Neural Networks with Divisia Money: Better Forecasts of Future In¯ation? Robert E. Dorsey 28 Part II Evidence from European Economies and the Planned EMU Area 3 Weighted Monetary Aggregates for the UK Leigh Drake, K. Alec Chrystal and Jane M. Binner 47 4 Weighted Monetary Aggregates for Germany Heinz Herrmann, Hans-Eggert Reimers and Karl-Heinz Toedter 79 5 Simple-sum versus Divisia Money in Switzerland: Some Empirical Results Robert Fluri and Erich Spoerndli 102 6 Weighted Dutch and German Monetary Aggregates: How Do They Perform as Monetary Indicators for the Netherlands? Norbert G. J. Janssen and Clemens J. M. Kool 120 7 Divisia Aggregates and the Demand for Money in Core EMU Martin M. G. Fase 138 Part III Evidence from the Paci®c Basin 8 Broad and Narrow Divisia Monetary Aggregates for Japan Kazuhiko Ishida and Koji Nakamura 173 v vi Contents 9 The Signals from Divisia Money in a Rapidly Growing Economy Jeong Ho Hahm and Jun Tae Kim 200 10 Divisia Monetary Aggregates for Taiwan Yen Chrystal Shih 227 11 Weighted Monetary Aggregates: Empirical Evidence for Australia G. C. Lim and Vance L. Martin 249 Part IV Evidence from North America 263 12 The Canadian Experience with Weighted Monetary Aggregates David Longworth and Joseph Atta-Mensah 265 13 Consequences of Money Stock Mismeasurement: Evidence from Three Countries Michael T. Belongia 292 Index 313 Introductory Comments, De®nitions, and Research on Indexes of Monetary Services Michael T. Belongia With apologies to Mark Twain, reporting practices of modern central banks beg the expression, `Lies, damned lies, and monetarydata .' Although demonstrably wrong in their construction, simple-sum measures of the money stock continue to be the of®cial data published by central banks and are used to guide policy decisions if monetary quantity variables are part of that process. Moreover, whether by tradition or ease of access, academic research also persists in using simple-sum monetary aggregates to test hypotheses about the effects of money on economic activity. In fairness to all involved, however, the conventional wisdom changes slowly. Indeed, less than thirty years have passed since Milton Friedman and Anna Schwartz, in MonetaryStatistics of the United States (1970) ended their discussion of the potential usefulness of weighted aggregates by concluding that, `So far there is only the barest beginning of an answer [of how to do it properly]' p. 152. Indeed, just prior to the publication of Friedman and Schwartz's book, two papers in the Federal Reserve Bank of St Louis Review were dramatic in that they called attention to money at all ± the now-famous study by Leonall Andersen and Jerry Jordan (1968) reporting a primary linkage between money and nominal spending (and the ineffective- ness of ®scal actions), and Karl Brunner's (1968) introduction of the term `monetarism', with a summary of its main principles. In some senses, these papers also marked the mid-point of a sweeping change in orthodox economics. Only nine years earlier, a paper by Brunner and Anatol B. Balbach presented evidence on money and economic activity that, in many ways, was more compelling than that of the Andersen±Jordan study. Disregarded by attendees of the Western Economic Association meetings of 1959, this paper is virtually unknown today. By 1979, however, arguments and evidence that could have been drawn directly from Brunner and Balbach were the basis of a fundamentally new focus for monetary policy: Most of the world's major central banks adopted monetary aggregate targeting in their efforts to control an accelerating rate of in¯ation. In view of this history, it is perhaps not 1 2 Introduction surprising that superlative indexes of the money stock are going through a typical gestation period prior to their broad acceptance. And, while new ideas are accepted slowly, it can also be said that no debate in economics is really `new'. From the ®rst discussions of the Equation of Exchange, economists knew that ®nding a measure for `M' was of central importance to empirical work. Schumpeter's (1954) Historyof Economic Analysis, for example, cites numerous views on the de®nition of money from both European and American perspectives over the period 1870±1911. Still, by the early 1930s, Lauchlin Currie was compelled to create his own money supply data to test the hypothesis that restrictive money growth caused the Great Depression. Why? As he put it at the time: It is a rather startling conclusion that the growth of money under the Federal Reserve System has been largely a matter of accident or, at best, an incidental by-product of the system's other policies. In this connection it is highly signi®cant that while an enormous mass of statistical data is available on the composition of member bank assets, there does not exist in any of the system's publications, so far as I am aware, a series of money.1 It was not until 1948 however, that monetary data for the USA were published by the Federal Reserve Board. It also is notable that those initial data were not revised and improved at the Board, but rather were guided by work by William Abbott under the direction of Homer Jones at St Louis. To many, all this Sturm und Drang produced one of the greater ironies in the history of economic thought: after two decades of effort to get the data reported, to convince people that money mattered, and to push central banks towards the adoption of monetary aggregates as intermediate targets ± everything went wrong. Previously stable velocity functions shifted quickly and erratically. The strong connection between money growth and in¯ation all but disappeared. Wildly alarmist warnings of a resurgent in¯ation were embarrassingly wrong. The role of a quantity variable in implementing monetary policy was discredited. Some observers have interpreted the events since 1980 as a clear repudiation of using monetary quantity variables for the conduct of policy. Others have remained steadfast in their belief that money has potent effects on economic activity, but admit that the published quantity data are erroneous indicators of what the central bank is doing. Still another group has focused on the possibility that fundamental problems of measurement may be responsible for the recent monetary turmoil. This volume is directed to providing empirical evidence on this last proposition. Progress on monetary measurement since 1970 After Friedman and Schwartz concluded that weighted monetary aggregates had intuitive appeal but were, as yet, not well de®ned in theory, a solution to Michael T. Belongia 3 the problem developed rather quickly. Using Erwin Diewert's (1976, 1978) results on aggregation and index number theory, William Barnett (1978) derived a measure of `prices' (user costs) for the ¯ow of monetary services from a stock of monetary assets. With these prices and the readily-available quantity data for monetary asset stocks, Barnett (1980) then applied an index from Diewert's class of superlative indexes ± the Divisia ± to create weighted monetary aggregates for the USA.2 The principles behind his new measures and a step-by-step guide to their construction were discussed at greater length in Barnett (1982). Although alternative superlative indexes could serve the same purpose, Barnett's careful and thorough examination of the Divisia index led to its adoption in most applications of weighted monetary aggregates.3 De®nitions of common concepts To avoid redundancies across papers in this book, some common de®nitions are provided here for general reference. Unless speci®cally noted otherwise in an individual chapter, the expressions below are those employed in each study. For greater detail on technical issues associated with adjusting data to match these general expressions, the reader is referred to Farr and Johnson (1985), Dietrich and Kliesen (1992), and the country-speci®c documentation in the individual chapters. A Divisia index of monetary service ¯ows is expressed as: Pk à à ÁlnDivMt 0:5 sit si;tÀ1 Álnqit , where sit is the share of total i1 th expenditures on monetary services allocated to the i asset at time t and qit is the quantity of balances in the ith asset category. The expenditure shares are Pk à à de®ned as: sit uit qit = uit qit , where uit is the user cost (rental price) of the i1 th à i asset. Nominal user costs are determined as uit {(Rt À rit )} / (1 Rt )} Pt , where Rt is the rate of return on a benchmark asset, rit is the own-rate of return th to the i asset and Pt is a cost-of-living index. The marginal tax rate also is included in Barnett's (1978) original derivation but, in the absence of a consistent time series for this concept (at least in the USA), it has been omitted in most subsequent studies.4 With the rit and qit readily-observable from market data and the use of the CPI or the GDP De¯ator as a proxy for Pt , treatment of Rt has been the major consideration of many researchers attempting to construct Divisia indexes.5 Indeed, of the three most frequent criticisms of Divisia monetary aggregates, discussions of the benchmark return have been among the most persistent.6 As the return on a completely illiquid asset (one that is incapable of producing any monetary services), Rt should be something akin to the rate of return on human capital in a world without slavery.
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