Functional monetary aggregates, monetary policy, and business cycles

Abstract

In this paper, we take the economic approach to monetary aggregation. In the context of highly disaggregated demand systems, encompassing the full range of monetary assets in the United States, we estimate the effectively globally regular minflex Laurent (ML) and normalized quadratic (NQ) flexible functional forms. We produce the ML and NQ functional monetary aggregates, consistent with neoclassical microeconomic theory, also addressing the issue of optimal monetary aggregation. We highlight the influence of measurement on statistical inference by investigating whether the ML and NQ functional monetary aggregates are of importance in resolving paradoxes associated with the measurement of money. In doing so, we also provide a comparison between the functional monetary aggregates and the Fed’s (broad) Sum M2 aggregate and the Center for Financial Stability (broad) Divisia M3 and Divisia M4 aggregates. Our detailed statistical analysis favors the functional monetary aggregates.