Editing Monetarism (section)

==Measurement Issues on the Stability of Money Demand==

While monetarism's influence on policy diminished in the 1980s, subsequent research suggests that the apparent instability in money demand functions may have stemmed from measurement issues rather than a fundamental breakdown in the money-income relationship. Barnett and others argued that simple-sum monetary aggregates, which weight all monetary components equally regardless of their liquidity characteristics, introduce significant measurement error that obscures stable underlying relationships.<ref>{{Cite journal |last=Barnett |first=William A. |date=1980 |title=Economic monetary aggregates an application of index number and aggregation theory |journal=Journal of Econometrics |volume=14 |issue=1 |pages=11–48 |doi=10.1016/0304-4076(80)90070-6}}</ref>

Studies using theoretically-grounded [[Divisia monetary aggregates]], which weight monetary components based on their "monetary services" or liquidity properties, have found considerably more stable money demand relationships. For instance, Belongia and Ireland demonstrated that money demand equations using Divisia measures remain stable even through periods of financial innovation and policy regime changes that destabilized traditional simple-sum specifications.<ref>{{Cite journal |last1=Belongia |first1=Michael T. |last2=Ireland |first2=Peter N. |date=2019 |title=The Demand for Divisia Money: Theory and Evidence |journal=Journal of Macroeconomics |volume=61 |pages=103128 |doi=10.1016/j.jmacro.2019.103128|url=http://fmwww.bc.edu/EC-P/wp937.pdf }}</ref>

This finding has important implications for monetary policy frameworks. The breakdown in simple-sum money demand relationships was a key factor in central banks abandoning monetary targeting in favor of interest rate rules. However, research using Divisia aggregates suggests that money could still serve as a useful policy indicator or intermediate target if properly measured.<ref>{{Cite journal |last1=Serletis |first1=Apostolos |last2=Gogas |first2=Periklis |date=2014 |title=Divisia Monetary Aggregates, the Great Ratios, and Classical Money Demand Functions |journal=Journal of Money, Credit and Banking |volume=46 |issue=1 |pages=229–241 |doi=10.1111/jmcb.12103}}</ref>

The stability of Divisia money demand functions has been demonstrated across different time periods and countries. For example, Hendrickson found that replacing simple-sum with Divisia measures resolves apparent instabilities in U.S. money demand, while similar results have been documented for other economies.<ref>{{Cite journal |last=Hendrickson |first=Joshua R. |date=2014 |title=Redundancy or Mismeasurement? A Reappraisal of Money |journal=Macroeconomic Dynamics |volume=18 |issue=7 |pages=1437–1465 |doi=10.1017/S1365100513000023}}</ref> Chen and Valcarcel argued that the properly measured monetary quantities and their holding costs maintain a stable, long-term cointegration.<ref>{{Cite journal |last1=Chen |first1=Zhengyang |last2=Valcarcel |first2=Victor J. |date=September 2024 |title=A granular investigation on the stability of money demand |journal=Macroeconomic Dynamics |language=en |pages=1-26 |doi= 10.1017/S1365100524000427}}</ref>

These findings suggest that the historical shift away from monetary aggregates in policy frameworks may have been premature and based on flawed measurement rather than a true breakdown in the relationship between money and economic activity. While most central banks continue to focus primarily on interest rates, the stability of properly-measured money demand functions indicates that monetary aggregates could potentially play a more prominent role in policy frameworks.<ref>{{Cite journal |last1=Barnett |first1=William A. |last2=Liu |first2=Jia |last3=Mattson |first3=Ryan S. |last4=van den Noort |first4=Jeff |date=2013 |title=The new CFS Divisia monetary aggregates: Design, construction, and data sources |journal=Open Economies Review |volume=24 |issue=1 |pages=101–124 |doi=10.1007/s11079-012-9251-7}}</ref>