Economics at your fingertips  

Neural Networks, VECM's and Divisia Money: Evidence from Taiwan

Alicia M. Gazely, Jane Binner and Shu-Heng Chen ()
Additional contact information
Alicia M. Gazely: Nottingham Trent University

No 5B.3, CeNDEF Workshop Papers, January 2001 from Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance

Abstract: Central banks continue to publish simple sum measures of the money stock and draw policy inferences from their behaviour even though it has been demonstrated conclusively that such data violate basic principles of economic and index number theory. (See, for example, Belongia (1996)). Simple sum aggregates are flawed index numbers because aggregating any set of commodities with equal weights implies that each good is a perfect substitute for every other good in the group. If measured money is to internalise pure substitution effects and track the true utility function associated with the monetary services gained from holding a given set of financial assets, monetary aggregates need to be constructed using an index formula from the class of superlative index numbers discussed by Diewert (1976). Barnett (1980) has demonstrated that the monetary index formulation devised by Divisia (1925) is the correct index to encapsulate a monetary aggregate and its concomitant price index. The construction has it roots firmly based in microeconomic aggregation theory and statistical index number theory. Barnett et al. (1992) provide a survey of the relevant literature, whilst Drake and Mullineux (1997) review the construction of Divisia indices and associated problems. Our hypothesis is that measures of money constructed using the Divisia index number formulation are superior indicators of monetary conditions when compared to their simple sum counterparts. Our hypothesis is reinforced by a growing body of evidence from empirical studies around the world which demonstrate that weighted index number measures may be able to overcome the drawbacks of the simple sum, provided the underlying economic weak separability and linear homogeneity assumptions are satisfied. Ultimately, such evidence could reinstate monetary targeting as an acceptable method of macroeconomic control, including price regulation. We offer an exploratory study of the relevance of the Divisia monetary aggregate for Taiwan over the period 1970 to date. In this way, we begin with a banking system that was heavily regulated by the Central Bank and the Ministry of Finance until 1989, which saw the introduction of the revised Banking Law in July. At the beginning of the 1980s, drastic economic, social and political changes took place creating a long-term macroeconomic imbalance. Rising oil prices caused consumer prices to rise by 16.3 per cent in 1981, followed by a period of near zero inflation in the mid eighties. From the nineties onwards, inflation has been fluctuating around the 5 per cent mark and hence the control of inflation has not been the mainstay of recent economic policy in Taiwan, unlike the experience of the western world. Rather, policy has focused more on achieving balanced economic and social development. The last two decades have witnessed a revolution in the financial and monetary sectors of Taiwan and indeed all the developed nations of the world. New types of financial assets and liabilities have emerged and new markets have been created, resulting from the liberalisation of the banking sector in the wake of the increased competition which is synonymous with the monetarist's creed. These changes have manifested themselves throughout the global economy in the emergence of competition and, more recently, merger activity between the traditional commercial banks and those financial institutions such as building societies, where activities had previously been kept separate from one another. The battle between banks and building societies in the last decade was responsible for within product innovation and the creation of new financial products. For example, interest payments on formerly non-interest bearing cheque accounts plus a wide range of new mortgage products were introduced by the banks whilst, in return, building societies began to offer cheque accounts, thereby bringing the banks and building societies into direct competition. This paper extends the work already conducted by Ford (1997) on the econometric performance of a new generation of Divisia indices that have been reformulated to take account of recent financial innovations in Taiwan. We adopt the principles of Ford by allowing both for a period of gradual learning by individuals as they adapt to the financial changes and secondly by incorporating a mechanism to accommodate the changing perceptions of individuals to the increased productivity of money. Individuals are thus assumed to adjust their holdings of financial assets until the diffusion of financial liberalisation is complete. The derivation of these two innovation adjusted Divisia series is described in more detail in Section 3. We use artificial neural network technology, in preference to standard econometric methods, to examine Taiwan's recent experience of inflation. This is an unusual tool in this context, although the application of neural networks in the field of economics is growing in popularity, as indicated by the diverse range of applications surveyed in Li et al. (1998). The paper proceeds with a discussion of the promise of neural network methodology in shedding new light on the Divisia index debate.

Date: 2001-01-04
References: Add references at CitEc
Citations: Track citations by RSS feed

There are no downloads for this item, see the EconPapers FAQ for hints about obtaining it.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link:

Access Statistics for this paper

More papers in CeNDEF Workshop Papers, January 2001 from Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance Dept. of Economics and Econometrics, Universiteit van Amsterdam, Roetersstraat 11, NL - 1018 WB Amsterdam, The Netherlands. Contact information at EDIRC.
Bibliographic data for series maintained by Christopher F. Baum ().

Page updated 2023-06-15
Handle: RePEc:ams:cdws01:5b.3