Concept of monetary aggregates
Monetary aggregates can be defined as the currency measures used in the monetary policy.
Types of monetary aggregates
M1 comprises immediate liquidity liabilities. It consists on paper-money in circulation and demand deposits. The paper-money in circulation is the result of the difference between the paper money issued by the Central Bank and the “cash” of the banking system. Demand deposits are those drawn by currency-producing banks and tradable by checks or electronic means. They comprise the group of money-making banks, commercial banks, multiple banks and savings banks. In this segment, credit cooperatives are not included, due to the insignificance of their deposits, as well as the difficulty of obtaining daily data and even monthly balance sheets. Public sector deposits are included in demand deposits, with the exception of National Treasury resources.
M2 includes, in addition to M1, investment deposits and high liquidity issuances carried out primarily in the domestic market by depository institutions – those that multiple credit.
M3 includes M2 plus domestic funding through fixed income funds and the net position of securities registered in the Special Settlement and Custody System arising from financing in repurchase agreements.
The M4 comprises the M3 and the highly liquid public debt securities.
Monetary aggregates and monetary policy
In the 1970s and 1980s, many countries began to use monetary aggregates as an appropriate monetary policy goal. First, monetary aggregates are under the direct control of monetary authorities in countries with flexible exchange rates. Thus, by modifying the monetary base, the authorities can neutralize the effects of unexpected changes in the behaviour of economic agents to achieve the desired nominal value of the monetary aggregate. Second, there is a great deal of empirical data suggesting that there is a stable demand for monetary aggregates, and hence predictable relationships between monetary aggregates and nominal income.
Third, new assumptions such as “rational expectations” have cast doubt on the merits of the monetary authorities’ previous strategy, if expectations are “rational” in that they are based on the best existing theories and information, efforts of monetary authorities to change those expectations were doomed to failure.
Consequently, monetary authorities in many industrialized countries, instead of attempting to change expectations, began to announce the values they wanted for monetary aggregates, thus summarizing their policy accordingly. The main objective was to facilitate the decision-making process and increase the confidence of the private sector since this policy reduced the possibility of erroneous decisions based on incorrect expectations.
In recent years, circumstances have forced several industrialized countries to modify their intermediate monetary policy goals. The United States abandoned its M1 target in 1987, Canada suspended the adoption of monetary targets in 1981, and Germany replaced its previous target with a new M3, which includes currency in circulation, demand deposits, time deposits of less than 4 years and deposit of institutional savings.
The main reasons for these changes were the innovations based on technical advances and the new regulatory standards, which would eliminate some of the advantages of meeting an announced target of a monetary aggregate as the monetary policy objective. In particular, technological progress in the areas of communication and transaction recording has reduced the cost of financial transactions. This reduction in transaction costs encouraged the creation of new financial instruments and the emergence of new financial intermediaries. This, in turn, has led to the deregulation of intermediaries and the strengthening of competition, innovation and increased efficiency of financial markets.
