Does money matter in the euro area? Evidence from a new Divisia index

Abstract

• Money has virtually disappeared from standard monetary models:• Empirical failures: estimated money demand functions found to be unstable; money proved to be less effective in predicting economic outcomes;• Policy shifts: central banks focus on interest rates;• Theory: development of theories suggesting that money is redundant.• Measurement problem?• Standard (simple sum) monetary aggregates were used, but:• E.g. cash and bank debt securities quite different, yet simple sum money aggregation assumes they are perfect substitutes • Correct aggregation: using either aggregation theory or index number theory;• Barnett (1980): use the discrete-time Törnquist-Theil approximation of the Divisia index;• Divisia money aggregates weight the components according to their "moneyness", i.e. according to their usefulness in making transactions;• For the US, it is found that money demand for divisia is stable; divisia works better than simple sum aggregates in VARs; divisia helps to predict inflation and nominal GDP (some recent works: Hendrickson (2013, Macr

Revisiting Money Demand in Malaysia: Simple-Sum versus Divisia Monetary Aggregates

“…Puah et al (2006) found that the long-run neutrality of money hypothesis does not hold in Malaysia, and monetary expansion measured using Divisia money appears to produce a positive effect on real output in the long run. Darvas (2014) also reveals that Divisia monetary aggregates are able to affect output, prices and interest rates in the Euro area.…”

Divisia monetary aggregates for a heterogeneous euro area

“…While Darvas (2015) provides a Divisia aggregate under the assumption of homogeneous interest rates across countries, there is still no publicly available Divisia aggregate that takes into account the heterogeneity of the euro area. In this section, we compute a euro area wide Divisia aggregate by adopting the heterogeneous country approach of Barnett (2007).…”

“…Assuming that euro area countries have already converged, he applied a single euro area wide interest rate for each of the monetary assets. Darvas (2015) proposed a Divisia aggregate for the euro area under similar homogeneity assumptions. However, since the run-up to the great recession, there has been a significant degree of heterogeneity in the level of interest rates and the composition of monetary assets in the euro area.…”

Money Neutrality, Monetary Aggregates and Machine Learning

“…The Divisia indices, originated from [4], apply different weights to different assets in accordance with the degree of their contribution to the flow of monetary services in an economy. The computation of the Divisia monetary aggregates for the Eurozone was conducted by [22] (the data is available at: http://bruegel.org/publications/datasets/divisia-monetary-aggregates-for-the-euro-area/).…”