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

William Barnett and Neepa B. Gaekwad
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Neepa B. Gaekwad: University of Kansas

Open Economies Review, 2018, vol. 29, issue 2, No 8, 353-371

Abstract: Abstract Monetary aggregates have a special role under the “two pillar strategy” of the ECB. Hence, 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 eleven EMU (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 (J Econ 136(2):457–482, 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 (J Bus Econ Stat 1:7–23, 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 and deposits with agreed maturity are income elastic and (ii) 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 provides Divisia monetary aggregates 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.

Keywords: Divisia monetary aggregation; European monetary union; Monetary aggregation theory; Multilateral aggregation; Minflex Laurent; Elasticities of demand (search for similar items in EconPapers)
JEL-codes: C43 C82 D12 E51 F33 (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (15)

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Working Paper: The Demand for Money for EMU: A Flexible Functional Form Approach (2017)
Working Paper: The Demand for Money for EMU: A Flexible Functional Form Approach (2017)
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DOI: 10.1007/s11079-017-9453-0

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