The Demand for Money for EMU: a Flexible Functional Form Approach

Abstract

Monetary aggregates have a special role under the "two pillar strategy" of the ECB. Hence, the need for a theoretically consistent measure of monetary aggregates for the European Monetary Union (EMU) is needed. This paper analyzes aggregation over monetary assets for the EMU. We aggregate over the monetary services for the EMU-11 countries, which include Estonia, Finland, France, Germany, Ireland, Italy, Luxembourg, Malta, Netherlands, Slovakia, and Slovenia. We adopt the Divisia monetary aggregation approach, which is consistent with index number theory and microeconomic aggregation theory. The result is a multilateral Divisia monetary aggregate in accordance with Barnett (2007). The multilateral Divisia monetary aggregate for the EMU-11 is found to be more informative and a better signal of economic trends than the corresponding simple sum aggregate. We then analyze substitutability among monetary assets for the EMU-11 within the framework of a representative consumer's utility function, using Barnett's (1983) locally flexible functional form, the minflex Laurent Indirect utility function. The analysis of elasticities with respect to the asset's user-cost prices shows that: (i) transaction balances (TB) and deposits redeemable at notice (DRN) are income elastic, (ii) the DRN display large variation in price elasticity, and (iii) the monetary assets are not good substitutes for each other within the EMU-11. Simple sum monetary aggregation assumes that component assets are perfect substitutes. Hence simple sum aggregation distorts measurement of the monetary aggregate. The ECB has Divisia monetary aggregates provided to the Governing Council at its meetings, but not to the public. Our European Divisia monetary aggregates will be expanded and refined, in collaboration with Wenjuan Chen at the Humboldt University of Berlin, to a complete EMU Divisia monetary aggregates database to be supplied to the public by the Center for Financial Stability in New York City.JEL Classification: C43, C82, D12, E51, F33.

The stability of demand for money in the proposed Southern African Monetary Union

“…to be fundamental in the recovery of the eurozone from negative externalities of the 2008 global financial crisis (Barnett & Gaekwad, 2018). Effectiveness of monetary policy implies that it is possible to forecast the effect of monetary policy.…”

Divisia monetary aggregates for a heterogeneous euro area

“…The 12 euro area countries under consideration account for more than 95% of the unions population and more than 97% of GDP, compare Table 2. Barnett and Gaekwad (2018) calculate a Divisia aggregate for a different set of countries including Estonia, Finland, France, Germany, Ireland, Italy, Luxembourg, Malta, the Netherlands, Slovakia, and Slovenia. Note that this group of countries covers a significantly lower share of the euro area, both in terms of population and GDP.…”

“…In the euro area, the shifts in the levels of monetary assets resulting from a simple reclassification of deposits are partly huge. Ignoring this issue of the ECB's level data can lead to spurious shifts in the Divisia aggregate, compare Barnett and Gaekwad (2018). Following Darvas (2015), this problem can be solved using the ECB's transactions data, as defined in the regulation ECB/2013/33: "Financial transactions are computed by the ECB as the difference between stock positions at end-of-month reporting dates, from which the effect of changes that arise due to influences other than transactions is removed."…”

On the monetary measures of global liquidity

“…Similarly, the investigation of studies using the CE technique also covers single country (Serletis and Molik 2000). However, some studies endeavour to construct Divisia monetary aggregation across the countries, despite having only been conducted on euro area (Barnett and Gaekwad 2018;Darvas 2015;Binner et al 2009;Stracca 2004;Barnett 2003). Another study of this sort is conducted only on the member countries of the Gulf Cooperation Council (Alkhareif and Barnett 2012).…”