The Barnett critique after three decades: A New Keynesian analysis

This paper extends a New Keynesian model to include roles for currency and deposits as competing sources of liquidity services demanded by households. It shows that, both qualitatively and quantitatively, the Barnett critique applies: while a Divisia aggregate of monetary services tracks the true monetary aggregate almost perfectly, a simple-sum measure often behaves quite differently. The model also shows that movements in both quantity and price indexes for monetary services correlate strongly with movements in output following a variety of shocks. Finally, the analysis characterizes the optimal monetary policy response to disturbances that originate in the financial sector.