An empirical investigation of separable monetary aggregates

Abstract

Defining monetary aggregates that are stable functions of a few economic variables, such as income and interest rates, is desirable for policy purposes. Defining weighted aggregates has proven useful for this purpose. However, the separability of monetary assets (needed to form consistent aggregates) has not been tested. Instead, the Fed's division of assets into M1 through L has been taken as given in the formation of weighted aggregates. Thus, it is not known whether these asset groups are treated as aggregates by asset holders. This dissertation tests the separability of various combinations of assets that presently comprise M1 and M2. Separability is tested first by way of a price dependent utility function and then by using a translog flexible functional form. Both functions possess no restrictions on their elasticities of substitution beyond those found in economic theory. Also, neither function is a subset of the other. The separability tests using the generalized Fechner-Thurstone (GFT) price dependent utility function indicates that the assets included in the conventional definition of M2 may be divided into three separable groups. Group one is composed of currency and demand deposits at both households and businesses. Group two consists of OCDs and savings deposits. And a third group includes overnight repurchase agreements and small time deposits. The separable results implied by the translog support the GFT division of assets. These results closely parallel the conventional asset division used by the Fed. This study however, differs in that it implies asset holders treat OCDs as savings assets instead of transactions assets.