Financial firm production of monetary and credit card services: An aggregation theoretic approach

Please cite the paper as:
William A. Barnett, Liting Su, (2018), Financial firm production of monetary and credit card services: An aggregation theoretic approach, World Economics Association (WEA) Conferences, No. 1 2018, Monetary Policy after the Global Crisis, 19th February to 20th April, 2018

Abstract

A monetary-production model of financial firms is employed to investigate supply-side monetary aggregation, augmented to include credit card transaction services. Financial firms are conceived to produce monetary and credit card transaction services as outputs through financial intermediation. While credit cards provide transactions services, credit cards have never been included into measures of the money supply. The reason is accounting conventions, which do not permit adding liabilities to assets. However, index number theory measures service flows and is based on aggregation theory, not accounting. Barnett, Chauvet, Leiva- Leon, and Su (2016) have derived and applied the relevant aggregation theory applicable to measuring the demand for the joint services of money and credit cards. But because of the existence of required reserves and differences in taxation on the demand and supply side, there is a regulatory wedge between the demand and supply of monetary services. We derive theory needed to measure the supply of the joint services of credit cards and money and to estimate the output supply function and the value added function. The resulting model can be used to investigate the transmission mechanism of monetary policy. Earlier results on the monetary policy transmission mechanism based on the correlation between simple sum inside money and final targets are not likely to approximate or even be relevant to results that can be acquired by empirical implementation of this model or its extensions. In particular, our financial-firm value-added measure and its supply function are fundamentally different from prior measures of inside money, shadow banking output, or money supply functions, on which much “real business cycle” theory is based. The data needed for empirical implementation of our theory will soon be available from the Center for Financial Stability in New York City and also to Bloomberg Terminal users.

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3 comment

  • monetarypolicyconferenceadmin says:

    Interesting model derived from the classical theories and adjusted to the contemporary times. Well done!

  • Qing Han says:

    Production side is fascinating and the masterful implementation of the Microeconomic theory guarantees the model is internally consistent! Production side analysis is easier for a typical firm, but that’s not the case for financial intermediaries which involve dealing with inside money. In perfect certainty case as in this paper, the outside money is the excess reserves. If we put into risk, banks will go to discount window to borrow from the Fed so as to increase the outside money. It would be exciting and practically important to see what kind of implications this might have on inside money!

  • William A. Barnett says:

    Qing, yes empirical implementation under risk could be a very important extension of the model, and would be very challenging, since the existence of credit rationing suggests that the usual assumptions of complete contingent claims markets may not apply. As you have correctly observed, this paper is about inside money. Outside money is a different matter. Long ago, the monetary base could be viewed as outside money, but that is no longer possible. In fact the monetary base has recently exceeded M1, which makes no sense. The problem is that the monetary base includes excess reserves, which now contains a vast amount of inside money. Some economists have attempted to produce an “outside base,” but no central banks provide those data.