I. INTRODUCTION This article uses an approach to long-run econometric modeling proposed by Pesaran et al. (2001; hereafter PSS) to develop an empirically weighted broad monetary aggregate for United States and to demonstrate advantages of this type of aggregate from a monetary policy perspective. In particular, we examine ability of this type of approach to deal with periods of significant financial innovation and money demand instability. A key requirement for monetary aggregates to provide a useful role in guiding monetary policy is that they should be stably related to objectives of policy, such as inflation or nominal income growth. In this context, United States has exhibited periodic evidence of significant money demand instability. Most notably, these have been Goldfeld's (1976) case of in 1973/74 and episode of early 1990s (Feldstein and Stock, 1996). In both cases, aggregate in question experienced a significant velocity increase and, as a consequence, previously established and apparently stable money demand relationships began to seriously overpredict growth in these aggregates. The missing M1 episode in 1973/74, together with subsequent evidence that M2 was more predictable than M1, led many economists to use M2 as an indicator of nominal activity. Hence, during 1980s, M2 became primary intermediate target of monetary policy. Furthermore, primacy of M2 appeared to be well supported by available empirical evidence. Feldstein and Stock (1994), for example, established that rate of change of M2 was a statistically significant predictor of rate of change of nominal gross domestic product (GDP) over period 1959-92. Furthermore, M2 remained statistically significant when short-term interest rates were added to relationship. Subsequent research, such as Miyao (1996) and Estrella and Mishkin (1997), however, cast doubt on robustness of this result. Carlson et al. (2000, p. 34), for example, summarize current situation by arguing that the promising empirical conclusions of Feldstein and Stock (1994) that established predictive content for M2 in a vector error correction setting do not seem to find support in data that extend through mid-1990s. The key factor behind breakdown in M2 relation appears to have been substitution away from time deposits and into mutual funds, particularly stock and bond mutual funds, in low interest rate environment of early 1990s. Although definition of M2 has been expanded by Federal Reserve in past to include money market mutual (MMMFs) and money market deposit accounts (MMDAs), for example, a number of analysts (Duca, 1995; Darin and Hetzel, 1994; Orphanides et al. 1994) have advocated that M2 should be expanded further to include these stock and bond mutual (M2+). Significantly, these studies typically use simple sum aggregation approach, in which all component assets are given equal and constant weights over time. This approach does not seem consistent, however, with accumulating evidence of a significant shift in wealth-holders preferences sometime in early 1990s. Carlson et al. (2000), for example, add to empirical evidence that had accumulated during 1990s by suggesting that instability was associated with a permanent upward shift in M2 velocity between 1990 and 1994. Furthermore, they argue that our results support hypothesis that households permanently reallocated a portion of their wealth from time deposits to mutual funds (p. 381). Clearly, simple sum aggregation is not able to take account of these changes in preferences. More significantly, however, simple sum aggregation cannot take account of any changes in relationship between component assets and nominal income over time. Although Carlson et al. (2000) do manage to reestablish a stable money demand relationship for MZM (money at zero maturity) and M2M (M2 minus small time deposits) aggregates through 1990s, this is only possible by specifically accounting for financial innovation that occurred in early 1990s. …