Divisia Money Research Articles

Testing the Effectiveness of Monetary Policy in Malaysia Using Alternative Monetary Aggregation

The capability of monetary aggregates to generate stable links with fundamental economic indicators verifies the effectiveness of monetary targeting. However, traditional monetary aggregates become flawed when financial reforms take place. As official monetary aggregates fail to maintain stable links with crucial economic indicators in Malaysia, monetary targeting has been substituted by interest rate targeting. Therefore, Divisia monetary aggregates, which are considered superior to their simple-sum counterparts are used in the investigation for Malaysia. The findings imply that Divisia M2 money demand is stable and capable of generating appropriate coefficients with correct signs for the variables included. Thus, Divisia money has shed new light on the usefulness of monetary targeting in formulating monetary policy in Malaysia.

Tests of different monetary aggregates for the monetary models of the exchange rate in five ASEAN countries

This study examines the usefulness of divisia money, relative to simple sum money, for exchange rate modelling in a period of rapid financial deregulation. This comparison is conducted using the monetary model of the exchange rate. In the long-run modelling, the divisia money is significantly superior to simple sum money in the case of Malaysia and the Philippines while indifferent for Indonesia, Singapore and Thailand.

A NOTE ON THE OPTIMAL LEVEL OF MONETARY AGGREGATION IN THE UNITED KINGDOM

Weak separability is a key admissibility property in the Divisia approach to monetary aggregation. We test groups of U.K. household sector monetary assets for weak separability using new data underlying the Bank of England's benchmark revision of its household sector Divisia index. Nonparametric tests are used to identify four monetary asset groupings, which are weakly separable over all or almost all of the post-ERM period (1992:4–2005:1). We construct Divisia monetary aggregates for these four groupings and investigate their information content in two applications. The main findings are that Divisia money has direct effects on aggregate demand and that the growth rates of the nominal Divisia monetary aggregates Granger cause nominal output growth, but not inflation.

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.

Money and macroeconomic performance: revisiting divisia money

Recent research suggests that the relation between money and the macroeconomy has sharply weakened in the U.S. after 1980. We reexamine this alleged breakdown by testing for cointegration between the macroeconomy and simple-sum and Divisia monetary aggregates. We check the robustness of our results by modeling multiple key breakpoints around the early 1980s. Unlike the case of simple-sum monetary aggregates, the evidence is overwhelming in its support for cointegration between Divisia money and macroeconomic variables, which persists despite several policy shifts and dramatic financial innovations in the post-1980 period. These results support Divisia money over simple-sum monetary aggregates as a guide in the implementation of monetary policy.

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)

Modeling the ECU Against the U.S. Dollar: A Structural Monetary Interpretation

The proposal that a reformed international monetary system be designed around currency blocs has gained some popularity of late. In Europe, the formation of the Euro formalizes the existence of a DM-based currency block. Little academic research has been conducted, however, on the properties of composite currencies such as the Euro. In this article, we examine the properties of the precursor to the Euro—namely, the ECU—against the U.S. dollar using a monetary framework. The article has several novel features: Our modeling strategy involves starting with underlying equilibrium conditions rather than a final reduced form; uses divisia money rather than the more conventional simple-sum money; interprets, in an economic sense, the long-run relationships; and produces an appealing forecasting performance.

Divisia money in a composite leading indicator of inflation

The principal objective of this paper is to compare the performance of the Divisia M4 monetary index with the standard Simple Sum measure of broad money in the context of composite leading indicators of inflation in the United Kingdom. Inflation targeting is an important component of current UK monetary policy and the construction of composite leading indicators of inflation is a potential advance over the current practice of monitoring a range of indicators of inflation. The leading indicators proposed provide useful turning point information for inflation and advocate principal component analysis as a more sophisticated weighting mechanism for the constituent components. Indicators constructed using a Divisia index measure of money were found to be more closely related to the inflation reference cycle than indicators using their Simple Sum counterparts when a principal components weighting mechanism was used.

Divisia money and income in Indonesia: some results from error-correction models, 1981:1-1994:4

The purpose of the present study is to provide alternatives to the monetary aggregates currently defined and published by Bank of Indonesia. The alternative monetary aggregate proposed is the Divisia aggregate which is an appropriate measurement for the monetary services of a country. In this paper we investigate the long-run relationship between income and Divisia aggregate together with its counterpart-the conventional simple-sum aggregate for the period 1981:1 to 1994:4. Using the cointegration and error-correction framework, our results indicate that there is potential role for the Divisia monetary aggregate as a useful intermediate indicator in the conduct of monetary policy in Indonesia.

The demand for money in an open economy: Some evidence for Canada

This paper presents estimates of an open-economy money demand function. A cash-in-advance model is constructed to motivate the specification of the demand for money in an open economy. Special attention is paid to unit root nonstationarity in the time series data. Econometric techniques designed to accommodate integrated and cointegrated variables are used to analyze the data. Canadian quarterly data for the period 1973:2–1990:1 are used. The results suggest that changes in the foreign interest rates and exchange rates affect the demand for Canadian real Divisia money.

The Demand for Divisia Money in a Core Monetary Union

Proponents of an aggregation theoretic approach to money demand argue that simple-sum measures do not capture the theoretical notion of money, especially for broad monetary aggregates. European monetary aggregation, which uses indices for monetary services, seems attractive because these indices can account for the imperfect substitutability between different currencies.

Exchange rates, financial innovation and divisia money: the sterling/dollar rate 1972–1990

In this paper we examine the usefulness of divisia money, relative to simple sum money, for exchange rate modelling in a period of rapid financial deregulation. This comparison is conducted using, as a convenient framework, the monetary model of the exchange rate. We demonstrate, inter alia, that for the sterling-US dollar exchange rate, over the period 1972: Q1 to 1990: Q2, that the use of divisia money makes a significant difference to both the long- and short-run modelling of the exchange rate.

The Demand for Divisia Money in the United States: A Dynamic Flexible Demand System

This paper applies the Anderson and Blundell (1982) approach to the analysis of the demand for money and attempts to establish the nature of the relationship between Divisia money, defined from narrow to broad, and the like assets at different levels of aggregation. This is achieved by conducting the analysis within a microtheoretical framework--utilizing the demand system approach--and by estimating a sequence of nested dynamic specifications and performing tests of the nested structures as well as on economic theory to establish the most restrictive dynamic specification acceptable to the data. Copyright 1991 by Ohio State University Press.

The Empirical Relationship Between Money, Prices, and Income Revisited

This article investigates the relationship between sum, Divisia, and monetary velocity money, prices, and income using the notion of Granger (1969) causality. This is achieved by evaluating empirically (using Dickey–Fuller unit-root tests) whether the macroeconomic time series under consideration are trend stationary or difference stationary and by conducting tests using three different, ad hoc, lag lengths—8, 6, and 4 quarters—as well as a statistically determined—using Akaike's (1969a,b) final prediction-error criterion—lag structure.

The demand for divisia M 1, M 2, and M 3 in the United States

This paper analyzes the demand for broad money measures and estimates the degree of substitution between Divisia money, defined from narrow to broad, and the “nested like assets” at different levels of aggregation. The analysis is conducted within a microtheoretical framework-utilizing the demand-system approach- and makes use of the Strotz-Gorman multistage optimization framework. Another pleasing feature of our approach is the systematic testing for the appropriateness of the weak separability (aggregation) conditions at the various levels of aggregation.