The Currency Equivalent Index and the Current Stock of Money

Abstract:     
The currency equivalent index (CE) has gained little acceptance as a monetary stock aggregate because it rests upon assumptions that do not match an important characteristic of the data. Specifically, total nominal expenditure on monetary services (TE) is assumed to follow a martingale process. Thus, it is unclear what, if anything, the CE measures. I attempt to answer this question by deriving the current stock of money (CSM), which is defined to be the discounted present value of the monetary service flows provided by only the current portfolio of monetary assets, and then analyzing the assumptions under which the CSM can be measured by the currency equivalent index.

The CSM would be a far superior measure of currency then the official measures of narrowly defined money, such as M1, because the CSM provides a measure of how much currency, an asset yielding only monetary service, would be necessary to replace the current monetary portfolio and provide the same level of monetary service. Narrowly defined aggregates that utilize simple sum methodology ignore monetary service provided by monetary assets not included in the aggregate. Moreover, M1, as calculated by the Federal Reserve, includes assets that yield return. Thus, even the narrow aggregates suffer from confounding of investment and monetary stocks.

The results suggest that the nominal user costs of monetary services can be predicted reasonably well by a martingale forecasting model and that the martingale forecasting model outperforms more sophisticated models. Moreover, a comparison of the CE to the CSM calculated under perfect foresight reveals that the CE closely tracks the CSM calculated under perfect foresight and that the CE exhibits little or no bias. Hence, I conclude that the currency equivalent index can be relied upon to be an unbiased and internally consistent measure of the CSM.

Number of Pages in PDF File: 31

Keywords: Currency Equivalent Index, Monetary Aggregation, Money Stock, Asset Pricing

JEL Classification: C43, E49

working papers series