The information content of the divisia monetary aggregates in forecasting inflation in the euro area

The paper investigates the performance of a set of monetary indicators, based on the Divisia money constructed for the euro area, on forecasting euro area inflation. The paper first briefly discusses on the relative information contents of the Divisia aggregates and the simple sum aggregates. The forecasting performance of the former is then examined by means of simulated out-of-sample forecasting. In addition to examining the information contents of the Divisia aggregate constructed for M3 money, the study also examines the performance of the Divisia M1 money to gain evidence on the relative performance between the broad and narrow Divisia monetary aggregates. According to the results, only some of the monetary indicators considered can significantly improve the univariate inflation forecasts. The Divisia M3 money based monetary indicators turned out to perform better than their Divisia M1 based counterparts. The result contradicts some previous evidence on the optimal level on monetary aggregation in the context of broad versus narrow money.      

Compression in monetary user costs in the aftermath of the financial crisis: implications for the Divisia M4 monetary aggregate

Differences in Divisia and simple-sum money arise from appropriate weighing mechanisms in Divisia, which rely on information on the user cost of monetary assets. We show convergence in the growth rate of Divisia M4 and its simple-sum counterpart beginning in early 2009, shortly after the collapse in the Federal Funds rate. This phenomenon results from compression in user costs.     

The application of neural networks to the Divisia index debate: evidence from three countries

If monetary policy is to be effective in controlling the macroeconomy, accurate measurement of the money supply is essential. The conventional way of measuring the level of the money supply is to simply sum the constituent liquid liabilities of banks. However, a more sophisticated, weighted monetary index has been proposed to take account of the varying degrees of liquidity of the short-term instruments included in money. Inferences about the effects of money on economic activity may depend importantly on the choice of monetary index because simple sum aggregates cannot internalize pure substitution effects. This hypothesis is investigated in the current paper. A Divisia index measure of money is constructed for the USA, UK and Italian economies and its inflation forecasting potential is compared with that of its simple sum counterpart in each of the three countries. The powerful Artificial Intelligence technique of neural networks is used to allow a completely flexible mapping of the variables and a greater variety of functional form than is currently achievable using conventional econometric techniques. The application of neural network methodology to examine the money-inflation link is highly experimental in nature and, hence, the overriding feature of this research is one of simplicity. Superior inflation forecasting models are achieved when a Divisia M2 measure of money is used in the majority of cases. This support for Divisia is entirely consistent with findings based on standard econometric techniques reported from the respective central and Federal Reserve banks of each country. Divisia monetary aggregates appear to offer advantages over their simple sum counterparts as macroeconomic indicators. Further, the combination of Divisia measures of money with the artificial neural network offers a promising starting point for improved models of inflation.     

Rational expectations and the demand for money: A nonparametric approach

This paper tests the U.S. demand for money for evidence of the effect of rational expectations of the income and interest rate variables that enter as arguments into that function. The data employed are simple-sum and Divisia aggregates, and the nonparametric tests are of the identification and information orthogonality of the various monetary measures. The Akaike Criterion is used to distinguish among the alternative specifications. While non-rationality is the typical result, Divisia aggregates appear to be more “rational” than simple sum. There is evidence of mean-reversion in interest rates as well.     

MONEY AND INFLATION IN INDIA: EVIDENCE FROM P‐STAR MODEL

This study uses P‐star model to examine the role of money in explaining inflation in India. In particular, we compare the performance of traditional Phillips curve approach against P‐star model in forecasting inflation. Moreover, the study estimates P‐star model using the alternative measures of money such as simple sum and Divisia M3, to examine the relevance of aggregation theoretic monetary aggregates in explaining inflation. The empirical results indicate that P‐star model with real money gap has an edge over traditional Phillips curve approach in forecasting inflation. More importantly, we found that the P‐star model estimated with Divisia real money gap performs better than its simple sum counterpart. These empirical findings suggest that the changes in real money gap play a crucial role in explaining inflation in India.     

货币中介目标的国际比较*——基于DAG SVAR模型

学术界围绕最优货币中介目标的选择,在利率、简单加总货币量、迪维西亚货币量之间争论不休。本文基于DAG SVAR模型,分别对美国、欧元区、英国的银行间隔夜拆借利率R、简单加总货币量M2、迪维西亚货币量D2对物价P、产出Y影响的相对重要性进行实证比较。结果发现,在美国,M2对Y的影响最大,R对P的影响最大;在欧元区,D2对Y的影响最大,M2对P的影响最大;在英国,M2对Y和P的影响都最大。总的来说,若货币最终目标是经济增长,则美国、英国的最优中介目标是简单加总货币量,欧元区的最优中介目标是迪维西亚货币量;若货币最终目标是物价稳定,则美国的最优中介目标是利率,欧元区、英国的最优中介目标是简单加总货币量。由此可见,对于不同的经济体或者不同的货币最终目标,最优中介目标的选择可能有所不同。本文的研究结论在一定程度上是对“利率普遍优于货币量,迪维西亚货币量普遍优于简单加总货币量”学术共识的反向补充。     

Financial Innovation and Divisia Money in Taiwan: Comparative Evidence from Neural Network and Vector Error-Correction Forecasting Models

In this article a Divisia monetary index is constructed for the Taiwan economy, and its inflation forecasting potential is compared with that of its traditional simple sum counterpart. The Divisia index is adjusted in two ways to allow for the financial liberalization that Taiwan has experienced since the 1970s. The powerful artificial intelligence technique of neural networks is used and is found to beat the conventional econometric techniques in a simple inflation forecasting experiment. The preferred inflation forecasting model is achieved using networks that employ a Divisia M2 measure of money that has been adjusted to incorporate a learning mechanism to allow individuals to gradually alter their perceptions of the increased productivity of money. The explanatory power of the two innovation-adjusted Divisia aggregates dominates that of the simple sum counterpart in the majority of cases. (JEL C4 , E4 , E5 )     

Monetary aggregates and core inflation: evidence from India

This study constructs a model-based core inflation for India using Divisia monetary aggregates instead of traditional money measures with the methodology proposed by Bagliano and Morana (2003) and evaluates its forecasting abilities. The core inflation derived from Divisia monetary aggregates is found to be a better leading indicator of measured inflation than the core inflation derived from traditional money measures. These results argue for a case in favour of using monetary aggregates in the construction of core inflation for policy purposes.     

Recent monetary policy and the credit card-augmented Divisia monetary aggregates

The main objective of this paper is to examine the information content of the credit card-augmented Divisia monetary aggregates and credit card-augmented Divisia inside monetary aggregates, recently produced by the Center for Financial Stability. We compare the inference ability of the credit card-augmented Divisia monetary aggregates and credit card-augmented Divisia inside monetary aggregates to the conventional Divisia monetary aggregates, at all levels of monetary aggregation. Using cyclical correlations analysis and Granger causality tests, we find that both the conventional Divisia monetary aggregates and the credit card-augmented Divisia monetary aggregates are informative in predicting output. Moreover, during, and in the aftermath of the 2007–2009 financial crisis, the credit card-augmented Divisia measures of money are more informative when predicting real economic activity than the conventional Divisia monetary aggregates. We also find that broad Divisia monetary aggregates provide better measures of the flow of monetary services generated in the economy.     

Reserves vs. federal funds operating monetary procedures: A general equilibrium analysis

The recently adopted reserves-operating target is compared to the old regime. It is found that: (a) the structure of the monetary system is changed, (b) success of the new regime hinges on understanding of the role of borrowed reserves, (c) a major reason for the recent violent gyrations in monetary aggregates—as well as in interest rates—is the Federal Reserve's formula for forecasting borrowed reserves.     

On the demand for money in the United States

One of the current issues in the literature on the demand for money is whether the adjustment of actual to desired money holdings is in real or nominal terms. This paper tests the real against the nominal adjustment hypothesis using United States data. Comparisons are made among simple sum and Divisia aggregates (of M1, M2, M3, and L) and with Spindt's monetary velocity (MQ) aggregate. The results strongly support the nominal adjustment hypothesis, but they do not reveal a single uniformly best monetary aggregate.     

Fiscal dependence on trade taxes and the level of economic development:: a comment

We test for fractional dynamics in US monetary series, their various formulations and components, and velocity series. Using the spectral regression method, we find evidence of a fractional exponent in the differencing process of the monetary series (both simple-sum and Divisia indices), in their components (with the exception of demand deposits, savings deposits, overnight repurchase agreements, and term repurchase agreements), and the monetary base and money multipliers. No evidence of fractional behaviour is found in the velocity series. Granger's (Journal of Econometrics, 25, 1980) aggregation hypothesis is evaluated and implications of the presence of fractional monetary dynamics are drawn.     

Interest on reserves,settlement, and the effectiveness of monetary policy

Over the last several years, the Federal Reserve has conducted a series of large scale asset purchases. The effectiveness of these purchases is dependent on the monetary transmission mechanism. Former Federal Reserve chairman Ben Bernanke argued that large scale asset purchases are effective because they induce portfolio reallocations that ultimately lead to changes in economic activity. Despite these claims, a large fraction of the expansion of the monetary base is held as excess reserves by commercial banks. Concurrent with the large scale asset purchases, the Federal Reserve began paying interest on reserves and enacted changes in its Payment System Risk policy. In this paper, I estimate the effect of the payment of interest on reserves (as well as other payment policy changes) on the demand for daylight overdrafts through Fedwire. Since Fedwire provides overdrafts at a fixed price, any fluctuation in the quantity of overdrafts is a change in demand. A reduction in overdrafts corresponds with an increase in the demand for reserves. I show that the payment of interest on reserves has had a negative and statistically significant effect on daylight overdrafts. Furthermore, I interpret these results in light of recent theoretical work. I argue that by paying an interest rate on excess reserves that is higher than comparable short term rates, the Federal Reserve likely hindered the portfolio reallocation channel outlined by Bernanke. Thus, the payment of interest on reserves increased payment processing efficiency, potentially at the expense of limiting the ability of monetary policy to influence economic activity.     

FORECASTING THE UK/US EXCHANGE RATE WITH DIVISIA MONETARY MODELS AND NEURAL NETWORKS

This paper compares the UK/US exchange rate forecasting performance of linear and nonlinear models based on monetary fundamentals, to a random walk (RW) model. Structural breaks are identified and taken into account. The exchange rate forecasting framework is also used for assessing the relative merits of the official Simple Sum and the weighted Divisia measures of money. Overall, there are four main findings. First, the majority of the models with fundamentals are able to beat the RW model in forecasting the UK/US exchange rate. Second, the most accurate forecasts of the UK/US exchange rate are obtained with a nonlinear model. Third, taking into account structural breaks reveals that the Divisia aggregate performs better than its Simple Sum counterpart. Finally, Divisia‐based models provide more accurate forecasts than Simple Sum‐based models provided they are constructed within a nonlinear framework.     

For they know not what they do: an analysis of monetary policy during the Great Moderation

In this article, we develop an empirical framework to show the importance of money during the Great Moderation, while accounting for the fact that monetary policy was exclusively conducted through interest rates. We estimate the impulse response functions and forecast error variance decomposition derived from a structural VAR with a least absolute shrinkage and selection operator–based lag selection. The variance decomposition suggests that a substantial component of macroeconomic variation has been driven by shocks to the money market, which were not only unintended by the Federal Reserve, but worse passed unnoticed allowing those shocks to accumulate over time.     

Currency equivalent monetary aggregates as leading indicators of inflation

This study examines whether the Currency Equivalent (CE) Monetary Aggregates proposed by [Hutt, 1963] and [Rotemberg et al., 1995] can perform better in predicting inflation as compared to their simple sum counterparts. The components of four official measures of monetary constructs - M1, M2, M3 and L1 - are used to construct monthly CE monetary aggregates for the period from April 1993 to June 2009. The empirical evidence indicates that the growth rate of CE aggregates has an edge over their sum counterparts in predicting inflation. Moreover, the predictive power of the growth rates of CE aggregates improves as the level of aggregation increases. These evidences suggest that observing the movements in the growth rates of weighted monetary aggregates can be a better option within the “multiple indicator approach” which is being currently practiced by the Reserve Bank of India.     

Disequilibrium macroeconomics, money as a buffer stock and the estimation of money demand

Standard explanations of the seeming instability of the money demand in the post-1973 period usually link to stories about financial innovation and deregulation. I propose an alternative hypothesis: Much of the seeming instability occurs because of shifts in monetary policy, either explicit or implicit, in an environment where the Federal Reserve controls a more “exogenous” money stock. My econometric analysis modifies existing methods for estimating markets in disequilibrium and incorporates newly developed cointegration and error-correction modeling. My findings provide support for the buffer-stock interpretation of the money market.     

Has the Fed been a failure?

As the 100th anniversary of the 1913 Federal Reserve Act approaches, we assess whether the nation’s experiment with the Federal Reserve has been a success or a failure. Drawing on a wide range of recent empirical research, we find the following: (1) The Fed’s full history (1914 to present) has been characterized by more rather than fewer symptoms of monetary and macroeconomic instability than the decades leading to the Fed’s establishment. (2) While the Fed’s performance has undoubtedly improved since World War II, even its postwar performance has not clearly surpassed that of its undoubtedly flawed predecessor, the National Banking system, before World War I. (3) Some proposed alternative arrangements might plausibly do better than the Fed as presently constituted. We conclude that the need for a systematic exploration of alternatives to the established monetary system is as pressing today as it was a century ago.     

An experimental examination of the house money effect in a multi-period setting

There is evidence that risk-taking behavior is influenced by prior monetary gains and losses. When endowed with house money, people become more risk taking. This paper is the first to report a house money effect in a dynamic, financial setting. Using an experimental method, we compare market outcomes across sessions that differ in the level of cash endowment (low and high). Our experimental results provide support for a house money effect. Traders’ bids, price predictions, and market prices are influenced by the amount of money that is provided prior to trading. However, dynamic behavior is difficult to interpret due to conflicting influences. JEL Classification C91 · C92 · D80 The views expressed here are those of the authors and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System.     

Federal deficits and the conduct of monetary policy

The persistent Federal deficits of the seventies and eighties have been accompanied by economic analysis of those deficits. One conclusion from this work is that deficits force the Federal Reserve to increase the money stock. However, empirical studies have failed to detect this link between deficits and money growth. This article attempts to resolve this contradiction through analysis of the influence of deficits on the instruments actually employed in conducting monetary policy. It is found that persistent deficits do lead to reserve growth but not through the expected interest-rate channel.