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27
Jan
2014

Empirical Performance of Monetary Aggregates in BEAC and BCEAO: Conclusion

Empirical Performance of Monetary Aggregates in BEAC and BCEAO: ConclusionThe forecasting power of monetary aggregates relative to price level and real GDP in BCEAO exhibits a different path. In that sense, traditional M1 performs a little better in forecasting inflation whereas Divisia M1 leads to better empirical performance in its ability to forecast real GDP. In sum, these results confirm the fact that at the narrowest level of aggregation, the difference between simple sum monetary aggregation and Divisia monetary should be very small. This evidence was provided by Barnett et al and Schunk. At level of aggregation broader than M1, the forecast evaluation leads to divergent conclusions relatively to each Central Bank. In the BEAC, no divergence emerges between the simple sum and Divisia monetary aggregate in their ability to forecast the price level. A careful observation of figure 18 shows that Divisia M2 has a slight edge over traditional M2 in predicting real GDP. Looking at the results from BCEAO, we can assert that the method of aggregation does not influence the forecasting ability of monetary aggregates. While the predictability power of Simple sum M2 and Divisia M2 with regard to real GDP is quite the same, Divisia M2 dominates traditional M2 as predictor of prices. In an effort to give some insights to our findings, we compute forecast RMSE from the VAR models (see table 4). The statistics in table 4 support the simple sum and Divisia comparisons offered above. We can also compare the ability of each monetary aggregate, irrespective of the type of monetary aggregate, to forecast price level and real GDP. Table 4 shows that the construction of Divisia monetary aggregates does not lead to substantial changes in targeting inflation and real GDP. The same conclusion is found by Elger et al. Banker-customer

The objective of this paper was to provide empirical evidence comparing the performance of simple sum and Divisia monetary aggregates. In fact, Divisia monetary aggregates were introduced by the seminal work of Barnett to overcome the theoretical deficiencies of simple sum monetary aggregates. Numerous studies have provided empirical comparisons of the Divisia aggregates to traditional aggregates. The majority of these studies were focused on developed economies and there is a quasi-absence of studies concerning African countries. Also, the majority of studies comparing the simple sum and Divisia monetary aggregates consider either their relative in sample performance or their out-of-sample method. This paper was mainly focused on the two approaches within the period 1992.1 and 2007.4. The first approach uses variance decomposition in an in-sample forecasting perspective. In the second approach, the forecasting exercise has been one of true out-of sample forecasting.
We find that the choice of monetary aggregation procedure is not crucial when evaluating the relationship between money and economic activity. In other words, none of the monetary aggregates dominate in their ability to target inflation and GDP.

Table 4: Forecast RMSE, alternative monetary aggregates

Central Bank Variables Price Level Real GDP
BEAC M1 0.0556 0.0937
M1D 0.0554 0.0932
M2 0.0554 0.0935
M2D 0.0556 0.0954
BCEAO M1 0.0549 0.1247
M1D 0.0550 0.1249
M2 0.0547 0.1248
M2D 0.0550 0.1247

The forecasting power of monetary aggregates relative to price level and real GDP in BCEAO exhibits a different path. In that sense, traditional M1 performs a little better in forecasting inflation whereas Divisia M1 leads to better empirical performance in its ability to forecast real GDP. In sum, these results confirm the fact that at the narrowest level of aggregation, the difference between simple sum monetary aggregation and Divisia monetary should be very small. This evidence was provided by Barnett et al and Schunk. At level of aggregation broader than M1, the forecast evaluation leads to divergent conclusions relatively to each Central Bank. In the BEAC, no divergence emerges between the simple sum and Divisia monetary aggregate in their ability

About The Author

Kevin J. Brandon

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