MONETARY AGGREGATION AND WEAK SEPARABILITY: A TEST OF HOUSEHOLD PREFERENCES OVER ASSETS AND COMMODITIES
HEAGHNEY, KENNETH J.
Doctor of Philosophy
Economic theory predicts that money is an important determinant of macroeconomic variables but fails to clearly define which assets should be considered money. Benjamin Friedman (1984) rejected the hypothesis that the major monetary aggregates move closely together over substantial periods of time. Thus, the central bank cannot simply pick one monetary aggregate, target it appropriately, and ignore mixed signals. Separability of preferences provides an explicit criteria for determining which assets should be considered as money. An aggregate based on separability will satisfy two properties. First, the total amount of the aggregate desired can be determined independent of the size of the aggregate's individual components. Second, changes in the relative size of the aggregate's components which leave the aggregate's total unchanged will not affect the choice of other assets and commodities. These properties indicate that an aggregate based on separability will have a more stable relationship with GNP than any other aggregate. Barnett (1980) first argued this proposition. Separability imposes structure on the Hessian matrix. Imagine a partition of the n goods of the choice set into m groups. If preferences are separable in this partition, the marginal rate of substitution between any pair of goods in the same group is independent of the level of consumption of any good which is not an element of that group. The result is two-level Hessian matrix corresponding to the partition. Theil translates this Hessian matrix into a two-level Rotterdam demand model. This model first allocates total expenditure among groups of goods. Next, each group allocation is allocated among the group's individual components. This two-level demand model permits the testing of alternate hypotheses regarding separable partitions of the choice set. Three separate partitions of choice set were tested. Each was rejected. Thus, the data do not support using separability to define a monetary aggregate for policy purposes.