The substitutability of monetary assets : a variable preferences approach

Abstract

Measurement of the elasticity of substitution between financial assets is an important element in evaluating the role that the assets play in the economy. In this thesis, a price dependent utility function is used to examine the issue of the nearness of money substitutes. Annual U.S. data for the period 1950-1975 and monthly U.S. data for the period 1983-1985 are used to estimate a linear logarithmic expenditure system for a wide array of monetary assets. Evidence is presented that utility function is not weakly separable in consumption of goods and monetary assets which is a key assumption in most of the models so far developed in this context. The results show low and variable substitution (complementarity) among the monetary assets. Further, it is found that the introduction of interest-bearing checking accounts has not, in practice, weakened the distinction between transactions accounts and savings accounts. Consequently, there is very little reason to believe that M1 has deteriorated as a measure of the public's transaction balances. The most important finding is that the elasticities of substitution are neither constant nor large enough to warrant the construction of simple sum aggregates.