I just posted this on The Money Illusion blog. As you may have noticed in the latest issue of the Economist
Magazine, The Money Illusion blog is highly respected.
Glad to see there is interest on this eminent blog about what I’m doing at the Center for Financial Stability (CFS) in NY City. That said, I probably should mention that interpretation of Divisia money is more difficult than it may seem. In index number theory, there are quantities, prices, and weights. With Divisia, the growth rate weights are the expenditure shares, which depend upon all quantities and prices, not just one price. The prices and the weights are not the same thing. With the Divisia monetary aggregates, the prices are foregone interest (opportunity costs). Those prices are not the same as the weights, but often are misinterpreted as weights.
Consider, for example, the case of a Cobb-Douglas aggregator function. The expenditure shares are constants for Cobb-Douglas. Regardless of what happens to the prices, the shares will not change. Hence the Divisia weights will not change.
What about other aggregator functions, not Cobb-Douglas? Suppose the price of a good goes up. Will its share (and thereby its Divisia weight) go up? That’s unpredictable, since it depends upon whether the own price elasticity of demand of the good is greater than or less than 1.0.
The CFS Reports section, which is not yet online, will try to help with accurate interpretation. My new book also does that in Appendix E. Once you get the hang of it, it all becomes clear. It’s all about the microeconomic aggregation theory that we all know from the CPI, the National Accounts, etc.