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Forecast Design in Monetary Capital Stock Measurement

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  • William Barnett

    (Department of Economics, The University of Kansas)

  • Unja Chae

    (Department of Economics, The University of Kansas)

  • John Keating

    (Department of Economics, The University of Kansas)

Abstract

We design a procedure for measuring the United States capital stock of money implied by the Divisia monetary aggregate service flow, in a manner consistent with the present-value model of economic capital stock. We permit non-martingale expectations and time varying discount rates. Based on Barnett¡¯s (1991) definition of the economic stock of money, we compute the U.S. economic stock of money by discounting to present value the flow of expected expenditure on the services of monetary assets, where expenditure on monetary services is evaluated at the user costs of the monetary components. As a theoretically consistent measure of money stock, our economic stock of money nests Rotemberg, Driscoll, and Poterba¡¯s (1995) currency equivalent index as a special case, under the assumption of martingale expectations. To compute the economic stock of money without imposing martingale expectations, we define a procedure for producing the necessary forecasts based on an asymmetric vector autoregressive model and a Bayesian vector autoregressive model. In application of this proposed procedure, Barnett, Chae, and Keating (2005) find the resulting capital-stock growth-rate index to be surprisingly robust to the modeling of expectations. Similarly the primary conclusions of this supporting paper regard robustness. We believe that further experiments with other forecasting models would further confirm our robustness conclusion. Different forecasting models can produce substantial differences in forecasts into the distant future. But since the distant future is heavily discounted in our stock formula, and since alternative forecasting formulas rarely produce dramatic differences in short term forecasts, we believe that our robustness result obviates prior concerns about the dependency of theoretical monetary capital stock computations upon forecasts of future expected flows. Even the simple martingale forecast, which has no unknown parameters and is easily computed with current period data, produces a discounted stock measure that is adequate for most purposes. Determining an easily measured extended index that can remove the small bias that we identify under the martingale forecast remains a subject for our future research. At the time that Milton Friedman (1969) was at the University of Chicago, the ¡°Chicago School¡± view on the monetary transmission mechanism was based upon the wealth effect, called the ¡°real balance effect¡± or ¡°Pigou (1943) effect,¡± of open market operations. Our research identifies very large errors in the wealth effects computed from the conventional simple sum monetary aggregates and makes substantial progress in the direction of accurate measurement of monetary-policy wealth effects.

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Bibliographic Info

Paper provided by University of Kansas, Department of Economics in its series WORKING PAPERS SERIES IN THEORETICAL AND APPLIED ECONOMICS with number 200516.

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Length: 69 pages
Date of creation: Aug 2005
Date of revision: Aug 2005
Handle: RePEc:kan:wpaper:200516

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Keywords: Monetary aggregation; Divisia money aggregate; economic stock of money; user cost of money; currency equivalent index; Bayesian vector autoregression; asymmetric vector autoregression.;

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References

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  1. Chetty, V K, 1972. "On Measuring the Nearness of Near-Moneys: Reply," American Economic Review, American Economic Association, vol. 62(1), pages 226-29, March.
  2. William Barnett & John Keating & Unja Chae, 2006. "The Discounted Economic Stock of Money with VAR Forecasting," Annals of Finance, Springer, vol. 2(3), pages 229-258, July.
  3. Richard G. Anderson & Barry Jones & Travis Nesmith, 1996. "Monetary aggregation theory and statistical index numbers," Working Papers 1996-007, Federal Reserve Bank of St. Louis.
  4. Julio J. Rotemberg & John C. Driscoll & James M. Poterba, 1991. "Money, Output and Prices: Evidence from A New Monetary Aggregate," NBER Working Papers 3824, National Bureau of Economic Research, Inc.
  5. Moroney, John R & Wilbratte, Barry J, 1978. "Money and Money Substitutes: A Reply," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 10(1), pages 115-16, February.
  6. William Barnett, 2005. "Monetary Aggregation," Macroeconomics 0503017, EconWPA.
  7. Donal J. Donovan, 1978. "Modeling the Demand for Liquid Assets: An Application to Canada (Etablissement d'un modèle de demande d'actifs liquides: application au Canada) (Construcción de un modelo de demanda de activos l," IMF Staff Papers, Palgrave Macmillan, vol. 25(4), pages 676-704, December.
  8. William A. Barnett & Melvin J. Hinich & Piyu Yue, . "The Exact Theoretical Rational Expectations Monetary Aggregate," Macroeconomics 0003004, EconWPA.
  9. Thomas Doan & Robert B. Litterman & Christopher A. Sims, 1983. "Forecasting and Conditional Projection Using Realistic Prior Distributions," NBER Working Papers 1202, National Bureau of Economic Research, Inc.
  10. William A. Barnett, 2004. "Multilateral Aggregation-Theoretic Monetary Aggregation over Heterogeneous Countries," Macroeconomics 0412009, EconWPA.
  11. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January.
  12. Peter N. Ireland, 2001. "The Real Balance Effect," Boston College Working Papers in Economics 491, Boston College Department of Economics.
  13. Litterman, Robert B, 1986. "Forecasting with Bayesian Vector Autoregressions-Five Years of Experience," Journal of Business & Economic Statistics, American Statistical Association, vol. 4(1), pages 25-38, January.
  14. repec:cup:macdyn:v:4:y:2000:i:2:p:197-221 is not listed on IDEAS
  15. William A. Barnett & Shu Wu, 2004. "On User Costs of Risky Monetary Assets," Macroeconomics 0406009, EconWPA.
  16. Diewert, W. E., 1976. "Exact and superlative index numbers," Journal of Econometrics, Elsevier, vol. 4(2), pages 115-145, May.
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  18. Milton Friedman & Anna Jacobson Schwartz, 1970. "Monetary Statistics of the United States: Estimates, Sources, Methods," NBER Books, National Bureau of Economic Research, Inc, number frie70-1, June.
  19. Barnett, William A., 1978. "The user cost of money," Economics Letters, Elsevier, vol. 1(2), pages 145-149.
  20. Keating, John W., 2000. "Macroeconomic Modeling with Asymmetric Vector Autoregressions," Journal of Macroeconomics, Elsevier, vol. 22(1), pages 1-28, January.
  21. Barnett, William A. & Hinich, Melvin J. & Weber, Warren E., 1986. "The regulatory wedge between the demand-side and supply-side aggregation-theoretic monetary aggregates," Journal of Econometrics, Elsevier, vol. 33(1-2), pages 165-185.
  22. Chetty, V Karuppan, 1969. "On Measuring the Nearness of the Near-Moneys," American Economic Review, American Economic Association, vol. 59(3), pages 270-81, June.
  23. Klein, Benjamin, 1974. "Competitive Interest Payments on Bank Deposits and the Long-Run Demand for Money," American Economic Review, American Economic Association, vol. 64(6), pages 931-49, December.
  24. Shiller, Robert J, 1979. "The Volatility of Long-Term Interest Rates and Expectations Models of the Term Structure," Journal of Political Economy, University of Chicago Press, vol. 87(6), pages 1190-1219, December.
  25. Hoover, Kevin D. & Perez, Stephen J., 1994. "Post hoc ergo propter once more an evaluation of 'does monetary policy matter?' in the spirit of James Tobin," Journal of Monetary Economics, Elsevier, vol. 34(1), pages 47-74, August.
  26. Joseph Bisignano, 1974. "Real money substitutes," Working Papers in Applied Economic Theory 17, Federal Reserve Bank of San Francisco.
  27. Steinhauer, Larry & Chang, John, 1972. "On Measuring the Nearness of Near-Moneys: Comment," American Economic Review, American Economic Association, vol. 62(1), pages 221-25, March.
  28. Samuelson, Paul A & Swamy, S, 1974. "Invariant Economic Index Numbers and Canonical Duality: Survey and Synthesis," American Economic Review, American Economic Association, vol. 64(4), pages 566-93, September.
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Cited by:
  1. Kelly, Logan, 2007. "Measuring the Economic Stock of Money," MPRA Paper 4914, University Library of Munich, Germany.
  2. William A. Barnett & Unja Chae & John W. Keating, 2006. "The discounted economic stock of money with VAR forecasting," Computing in Economics and Finance 2006 51, Society for Computational Economics.

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