The study also suggests that for effective policy formulation M2 monetary aggregate
is the right aggregate to consider.
Because of the disappearance since 1981 of a monetary aggregate
like M1 that is useful as a predictor of nominal GDP, it is necessary to refocus the search for robust correlations based on the monetarist hypothesis that monetary disorder originates in central bank interference with the operation of the price system.
The conventional method to identify a contractionary monetary policy shock assumes that a contractionary monetary policy shock is associated with increases in the short-term interest rates or decreases in the monetary aggregate
. Nevertheless, we argue that such an identification scheme, useful as it may be for a closed economy, is not suitable for identifying monetary policy shocks of a small open economy.
Since its inception, the ECB has evaluated monetary developments relative to a "reference value" for growth in the monetary aggregate
If velocity is variable and unpredictable, the relationship between money and prices is difficult to characterize, and monetary aggregates
can't help policymakers track inflation.
We show that changing the monetary aggregate
measure from M1 to MZM from 1980 onward preserves the long-run relationship between real money, the opportunity cost of money, and economic activity up to a constant factor.
What is required is a monetary aggregate
that can endogenously respond to changes in wealth holder preferences, possibly caused by financial innovations, which impinge on the information content of monetary aggregates
or their sub components.
In this structure, the shock to the monetary aggregate
is equivalent to the residual error from the reduced-form equation.
Economic aggregation theory provides methods for choosing which assets to include in a monetary aggregate
and how to construct aggregator functions, whereas index number theory provides parameter- and estimation-free methods to perform the aggregation.
(4) The monetary policy frameworks of many Latin American central banks have used the information conveyed by a monetary aggregate
to conduct monetary policy, but the other two elements (public announcements of the targets and some type of accountability mechanism) rarely have been present at the same time.
The findings depend greatly on the monetary aggregate
used to measure money growth.
The existence of an identifiable and stable demand function is an important requirement for any monetary aggregate
that serves as an intermediate target.
One nominal anchor used by almost all central banks at one time or another is a target growth path for a monetary aggregate
such as the monetary base or M1, M2, or M3.
Divisia Aggregate Component Assets D4 Notes and coins, NIB sight deposits, IB sight deposits, and bank time deposits D7 As above plus building society deposits, National Savings investment accounts, and CDs In addition to the construction of the two Divisia monetary aggregate
quantity indices, we compute the implicit Divisia rental price or user cost indices, P4 and P7, which are also utilised in the subsequent money demand analysis.
Johansen tests are first conducted using the M1 or M2 monetary aggregate
and industrial output or the price level, with results showing cointegration between each monetary aggregate
and output, as well as between each aggregate and the price level.(12)