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MEASUREMENT ERROR IN MONETARY AGGREGATES: A MARKOV SWITCHING FACTOR APPROACH

Published online by Cambridge University Press:  15 September 2009

William A. Barnett ,
Marcelle Chauvet  and
Heather L. R. Tierney
William A. Barnett
Affiliation:
University of Kansas
Marcelle Chauvet*
Affiliation:
University of California, Riverside
Heather L. R. Tierney
Affiliation:
College of Charleston
*
Address correspondence to: Marcelle Chauvet, Department of Economics, University of California, Riverside, CA 92521-0247, USA; e-mail: chauvet@ucr.edu.
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Abstract

This paper compares the different dynamics of the simple-sum monetary aggregates and the Divisia monetary aggregate indices over time, over the business cycle, and across high and low inflation and interest-rate phases. Although traditional comparisons of the series sometimes suggest that simple-sum and Divisia monetary aggregates share similar dynamics, there are important differences around turning points that cannot be evaluated by their average behavior. We use a factor model with a regime-switching model that separates the common movements underlying the monetary aggregate indices from idiosyncratic variations in each series. We find that the major differences between the simple-sum aggregates and Divisia indices occur around the beginnings and ends of recessions and during some high-interest-rate phases. We note the inferences' policy relevance, which is particularly dramatic at the broadest (M3) level of aggregation. Indeed, as Belongia [Journal of Political Economy, 104 (5) (1996), 1065–1083] has observed in this regard, “measurement matters.”

Keywords

Measurement ErrorMonetary AggregationDivisia IndexAggregationState SpaceMarkov SwitchingMonetary PolicyIndex Number TheoryFactor Models
Type
Articles
Information
Macroeconomic Dynamics , Volume 13 , Supplement S2: Measurement with Theory , September 2009 , pp. 381 - 412
Copyright
Copyright © Cambridge University Press 2009

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