A Note on the Policy Implications of Using Divisia Consumption and Monetary Aggregates

Abstract

Using U.K. data that are consistent with utility maximizing behavior by consumers, we construct aggregates for both consumption goods (nondurables and services) and monetary assets that are consistent with economic aggregation theory. Using these aggregates and the stock of durable goods, we estimate the elasticities of substitution between various consumption goods and monetary assets. These estimates are compared to the corresponding results from conventional monetary and consumption aggregates. The results give important information for monetary policy and the monetary transmission mechanism. In particular, these substitution estimates provide insight into the recent changes in expenditure on durable goods. We also show that the use of conventional U.K. consumption and monetary aggregates often give incorrect estimates of substitution and can provide misleading policy insights.

Substitution between monetary assets and consumer goods: New evidence on the monetary transmission mechanism

“…The user cost for both durable and semi-durable goods is calculated using the formula of Diewert (1974) and Patterson (1991) with the assumed average life lengths used to calculate the appropriate depreciation rates (see Drake and Fleissig, 2008), and using the benchmark rate of return derived for monetary assets. 10…”

“…is the depreciation rate, p it is the price of good i, and E t p it+1 is the expected price of good i. data violate revealed preference over the sample 1977.1-2005.3 as in Drake and Fleissig (2008) and Elger et al (2008). Thus conclusions about optimal consumer behavior over the sample 1977.1-2005.3 are a joint test of utility optimization and misspecification of the utility function.…”

“…Given the conversion of many large building societies into plc banks, using a sample where the data are consistent with GARP is likely to provide more precise estimates of substitution because the data can be rationalized by a data generating function. Consequently, we follow the approach of Belongia and Chalfant (1989), Whitney (1987, 1988), Drake and Fleissig (2008) and Elger et al (2008) to establish a sample that is consistent with utility optimization. Additional testing established that the data are consistent with GARP over the period 1990.1-2005.3 which implies that there exists a utility function over this sample that rationalizes the data.…”

“…The indirect utility function is approximated using the Fourier flexible form which has been used in money demand studies by Ewis and Fisher, 1985;Fisher, 1992;Barnett et al, 1992;Fisher and Fleissig, 1997;Drake and Fleissig, 2008). The Fourier flexible form can globally approximate the levels and partial derivatives of a continuous utility function and give unconstrained estimates of substitution.…”

Revealed preference tests for weak separability: An integer programming approach

“…See, for example, Swofford andWhitney (1987, 1988), Barnhart and Whitney (1988), Patterson (1991), Belongia and Chrystal (1991), Choi and Sosin (1992), Swofford and Whitney (1994), Jones and Mazzi (1996), Cox (1997), Fisher and Fleissig (1997), Rickertsen (1998), Spencer (2002, Whitney (2003, 2008), Swofford (2005), Serletis and Rangel-Ruiz (2005), Jones, Dutkowsky, and Elger (2005), Jha and Longjam (2006), Blundell, Browning, and Crawford (2007), Hjertstrand (2007, 2009), Elger, Jones, Edgerton, and Binner (2008, Elger and Jones (2008), and Drake and Fleissig (2008). 7 We refer to Garey and Johnson (1979) for an introduction into the theory of np-completeness.…”