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The Demand for Assets and Optimal Monetary Aggregation

by Serletis, Apostolos and Jadidzadeh, Ali

This paper uses a highly disaggregated demand system to estimate the degree of substitutability among monetary assets and to address the issue of optimal monetary aggregation in the United States. We address the problems of dimensionality and nonlinearity, estimating a very detailed monetary asset demand system encompassing the full range of assets based on the locally ‡exible normalized quadratic (NQ) expenditure function. We treat the con- cavity property as a maintained hypothesis and provide evidence consistent with neoclassical microeconomic theory. Statistical tests reject the appropri- ateness of the aggregation assumptions for all the money measures published by the Federal Reserve as well as for a large number of groupings suggested by earlier studies. This supports and reinforces Barnett’s (2016) assertion that we should employ the broadest M4 monetary aggregate published by the Center for Financial Stability.

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