Journal of Econometrics 33 (1986) 165-185. North-Holland zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQP THE REGULATORY WEDGE BETWEEN THE DEMAND-SIDE AND SUPPLY-SIDE AGGREGATION-THEORETIC MONETARY AGGREGATES* William A. BARNETT and Melvin J. HINICH zyxwvutsrqponmlkjihgfedcbaZ Unioersi~ of zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONML Texas, Austin, TX 78705, USA Warren E. WEBER Federal Reserve Bank of Minneapolis, MN 55480, USA Bamett introduced the use of neoclassical demand-side aggregation theory into monetary econom- ics. More recently he has introduced supply-side aggregation theory into monetary economics. We show that the demand-side and supply-side exact monetary aggregates need not be equal, even if aggregation is over the same component assets on both sides of the market and if all component- asset markets are cleared. The non-payment of interest on required reserves produces a classical regulatory wedge between the two sides of the aggregate market. We use time-series methods, including a new Hilbert transform method, to investigate the empirical importance of this aggregate gap. 1. Introduction 1.1. The issue Bamett (1980a; 1981, ch. 7) introduced the use of neoclassical aggregation and index number theory into monetary economics. His Divisia aggregates, based upon Diewert’s (1976) superlative class of index numbers, measure the economy’s flow of monetary services, as perceived by the users of those monetary services. As a result, the relevant aggregation theory is that produced by neoclassical consumer and factor demand theory. Much empirical research now exists on that subject; and, as would be expected from the theory, the empirical research is mostly related to demand-side empirical tests.’ More recently Bamett (1986) has introduced the Divisia supply monetary aggre- *The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or of the Federal Reserve System. We have benefited substantially from the research assistance of Salam Fayyad. This research was partially supported by National Science Foundation Grant SOC89305162. ‘See, e.g., Bamett (1982b,1983a,1984) and Barnett, Offenbacher and Spindt (1981,1984). The Federal Reserve Board calls Bamett’s monetary aggregates the Monetary Services Indexes. 0304~4076/86/$3.5001986, Elsevier Science Publishers B.V. (North-Holland)