bain_y_howells__monetary_economics__policy_and_its_theoretical_basis

according to the extent to which they provide transactions services. If this
could be done accurately, then the resulting index should measure the quantity
of money available in the economy for transactions purposes and should
be more closely linked to expenditure and income.
The weights given to each asset are often said to represent the ‘user cost’
of the asset. To measure the user cost, we must first choose a benchmark
asset which provides no transactions services. For example, the Bank of
England has published a Divisia index going back to 1977 based upon the
components of M4 and using the rate on three-month local authority
deposits (the 3mLA rate) as the benchmark. In order to construct the index,
we subtract the rate of interest on the component asset from the rate on the
benchmark asset. Notes and coin are given a weight of one representing the
difference between the 3mLA rate and zero. Each other asset, a i, is then
given a lesser weight, w i, equal to the difference between the benchmark
rate and its own rate, i i, as a fraction of the benchmark-notes and coin differential.
In symbols:
w i = (3mLA rate - i i)/(3mLA rate - 0) ...2.4
The index, D, is then the sum of the nominal value of each asset adjusted
for its appropriate weight:
D = Σa iw i
DEFINITIONS OF MONEY IN ECONOMICS 45
If it is the transactions services of money in which we are primarily interested,
then Divisia clearly possesses numerous attractions. There are some
problems though. Firstly, it is still not clear that such an index is measuring
transactions services alone since bank accounts give access to other banking
services for their holders. Secondly, in using interest rate differentials
to measure user cost we are assuming that interest rates are equilibrium rates
in a perfectly competitive system. A characteristic of the UK monetary sector
in the 1980s, however, was a marked increase in competition especially
between banks and building societies. For earlier periods, therefore, it
seems unlikely that this condition holds. Thirdly, unless we assume that
portfolio adjustments are instantaneous, and this is not suggested by evidence,
then the weighted components are unlikely to have equilibrium values.
For example, if the rate on an asset increases, the differential with the
benchmark asset (and thus the weight) diminishes. But until holdings of
that asset have adjusted to its new own rate, the re-calculated weight will be
attached to an asset quantity which is too small. Since we are dealing with
an index derived from numerous assets and interest rates and since the lat-