Empirical Studies on the Demand for Monetary Services in the UK
Abstract: Many economic models contain the single variable 'money'. Money does not exist in the form of a single physical unit and it is common to construct monetary aggregates using the method of simple summations. Monetary aggregation theory lends little or no support to the method of simply summing various monetary asset components up to arbitrary levels of aggregation. In monetary aggregation theory, monetary assets are treated as durable goods rendering a flow of services. Microeconomic aggregation theory provides rigorous conditions under which an aggregate over a group of monetary assets can be constructed and index number theory provides parameter- and estimation-free approximations of unknown aggregator functions. In the monetary aggregation literature, it is common to construct monetary services indices (MSI's) using a discrete time approximation of the Divisia index. In the first study included in this thesis, a 'capital certain' MSI is compared to a 'risky' MSI within a cointegration money demand framework. The capital certain MSI contains the same assets that are included in the official Bank of England MSI plus national savings investment accounts. The risky MSI contains the same assets that are included in the capital certain MSI plus three assets with substantial interest rate risk: bonds, shares and unit trusts. The inclusion of 'risky' assets into MSI's is motivated by both financial innovations that have increased the liquidity of such assets and recent developments in monetary aggregation theory that allow for interest rate risk in combination with risk aversion. The cointegration analysis reveals no apparent gain from the inclusion of risky assets in terms of consistency of the results with economic theory nor stability. Some problems are detected in the construction of the risky MSI. In the second study included in this thesis, tests for weak separability are performed. Weak separability is the fundamental existence condition for an aggregate over any group of goods. All capital certain assets are found to be weakly separable from non-durables, services and leisure over the larger part of the 90's. Two extensions aimed at relaxing the deterministic nature of the weak separability tests turn out difficult to interpret. In the final study included in this thesis, the demand for monetary assets is studied within a consumer demand framework. Since the data may be non-stationary, a linearised system is used. This system is estimated in first differences. The sample is based on the results from the weak separability study. The estimated system conforms to homogeneity- and symmetry restrictions. Elasticity estimates are consistent with economic priors.
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