Logan J. Kelly

The Stock of Money and Why You Should Care

In this paper, I will examine the problems created by incorrectly using a simple sum monetary aggregate to measure the monetary stock. Specifically, I will show that simple sum monetary aggregate confounds the current stock of money with the investment stock of money and that this confounding leads the simple sum monetary aggregate to report an artificially smooth monetary stock. This smoothing causes important information about the dynamic movements of the monetary stock to be lost. This may offer at least a partial explanation of why so many studies find that money has little economic relevance. To that end, we will conclude the paper by examining a reduced form backward looking IS equation to determine whether monetary aggregates contain information about real GDP gap. This paper differs from previous work in that it focuses on smoothing of the monetary stock data caused by the use of simple sum methodology, where the previous work focuses on the bias exhibited by simple sum monetary aggregates.

The Quantity Theory Revisited: A New Structural Approach

While the long run relation between money and inflation is well established, empirical evidence on the adjustment to the long run equilibrium is very heterogeneous. In this paper, we show that the development of US consumer price inflation between 1960Q1 and 2005Q4 is strongly driven by money overhang. To this end, we use a multivariate state space framework that substantially expands the traditional vector error correction approach. This approach allows us to estimate the persistent components of velocity and GDP. A sign restriction approach is subsequently used to identify the structural shocks to the signal equations of the state space model that explain money growth, inflation, and GDP growth. We also account for the possibility that measurement error exhibited by simple-sum monetary aggregates causes the consequences of monetary shocks to be improperly identified by using a Divisia monetary aggregate. Our findings suggest that when the money is measured using a reputable index number, the quantity theory holds for the United States.

A Model of Monetary Policy Shocks for Financial Crises and Normal Conditions

In late 2008, deteriorating economic conditions led the Federal Reserve to lower the federal funds rate to near zero and inject massive liquidity into the financial system through novel facilities. The combination of conventional and unconventional measures complicates the challenging task of characterizing the effects of monetary policy. We develop a novel method of identifying these effects that maintains the classic assumptions that a central bank reacts to output and the price level contemporaneously and may only affect these variables with a lag. A New-Keynesian DSGE model augmented with a representative financial structure motivates our empirical specification. The equilibrium model provides theoretical support for our choice of different series to replace variables that were popular in models of monetary policy but became problematic in the aftermath of the 2008 financial crisis. One of our most important innovations is to utilize the Divisia M4 index of money as the policy indicator variable. The model is bolstered by its ability to produce plausible responses to a monetary policy shock in samples that include or exclude the recent crisis period.

Measuring economic conditions: an extension of the Stock/Watson methodology

This study develops an economic indicator tailored to measure economic conditions at the state level by recognizing that a states economy is an integrated part of the region and responds to both regional and national economic outlooks. This article applies our methodology to the state of Rhode Island. In the case of Rhode Island, the addition of a regional economic indicator appears to make a significant improvement over the Federal Reserve Bank (FED) of Philadelphia coincident index. Therefore, this preliminary study indicates that it is worthwhile to expand this project to include all 50 states.

The current stock of money: an aggregation theoretic measure of narrowly defined money

While the usual definition of narrowly defined money is in terms of grouping of assets to be included in the aggregate, the Current Stock of Money (CSM) focuses on the function of those assets. By isolating the portion of each monetary asset that functions as currency, the CSM measures the amount of currency needed to provide an equal level of monetary service to that of the current monetary portfolio. This makes the CSM suitable for use in any model that contains currency, that is, narrowly defined money. Thus, the main contributions of this research are to derive the CSM and to show that the Currency Equivalent (CE) index is an unbiased measure of the CSM.

The Currency Equivalent Index and the Current Stock of Money

The currency equivalent index provides an elegant method for measuring the stock of money, but it rests upon assumptions that do not match an important characteristic of the data. Thus, it is unclear what, if anything, the CE measures. This paper attempts to answer this question by deriving the current stock of money (CSM), which is defined to be the discounted present value of the monetary service flows provided by only the current portfolio of monetary assets, and then analyzing the assumptions under which the current stock of money can be measured by the currency equivalent index.

Modelling Money Shocks in a Small Open Economy: The Case of Taiwan

This paper explores the relevance of the Divisia monetary aggregate in Taiwan over the period January, 1985 through to June, 2016. We apply a block recursive structural Vector Autoregressive (VAR) approach that is adapted to a small open economy by adding the New Taiwan Dollar/US Dollar exchange rate to the block of economic activity indicators. We test the hypothesis that measures of money constructed using the Divisia index number formulation are superior indicators of monetary conditions when compared to the central banks main policy rate, the Taiwanese discount rate. We find that using properly measured monetary data solves short‐run price, output and exchange rate puzzles and leads to sensible long‐run impulse responses to monetary shocks. Future work on the optimization of the construction of the Divisia index number formulation is recommended.

For they know not what they do: an analysis of monetary policy during the Great Moderation

ABSTRACT In this article, we develop an empirical framework to show the importance of money during the Great Moderation, while accounting for the fact that monetary policy was exclusively conducted through interest rates. We estimate the impulse response functions and forecast error variance decomposition derived from a structural VAR with a least absolute shrinkage and selection operator–based lag selection. The variance decomposition suggests that a substantial component of macroeconomic variation has been driven by shocks to the money market, which were not only unintended by the Federal Reserve, but worse passed unnoticed allowing those shocks to accumulate over time.

Toward a Better Measure of Real Time Economic Conditions: An Application of the Stock/Watson Methodology to the Case of Rhode Island

This study develops an economic indicator tailored to measure economic conditions at the state level by recognizing a states economy is an integrated part of the region and responds to both regional and national economic outlooks. This paper applies our methodology to the state of Rhode Island. In the case of Rhode Island, the addition of a regional economic indicator appears to make a significant improvement over the the Philadelphia FED Coincident Index. Moreover, the robustness analysis above shows that economic indicator developed to tracks the business cycles in Rhode Island perform quite well and that the indicator is robust to various identification schemes. Therefore, we believe this preliminary study indicates that it is worthwhile to expand this project to include all fifty states.