Redundancy or Mismeasurement? A Reappraisal of Money

The emerging consensus in monetary policy and business cycle analysis is that money aggregates are not useful as an intermediate target for monetary policy or as an information variable. The uselessness of money as an intermediate target is driven, at least in part, by empirical research that suggests that money demand is unstable. In addition, the informational quality of money has been called into question by empirical research that fails to identify a relationship between money growth and inflation, nominal income growth, and the output gap. Nevertheless, this research is potentially flawed by the use of simple sum money aggregates, which are not consistent with economic, aggregation, or index number theory. This paper therefore re-examines previous empirical evidence on money demand and the role of money as an information variable using Divisia monetary aggregates. These aggregates have the advantage of being derived from microtheoretic foundations as well as being consistent with aggregation and index number theory. The results of the re-evaluation suggest that previous empirical work might be driven by mismeasurement.