The Effects of Financial Innovations on the Measurement, Control and Efficacy of the M1 and M2 Aggregates

This paper describes the financial innovations hypothesis that M1, but not M2, has been significantly affected by the introduction and growth of these new assets. An alternative hypothesis, called the competitive markets hypothesis here, has implications that are nearly the opposite of the financial innovations hypothesis. It suggests that the demand, desired use and composition of M2 were unaffected by the introduction of so called interest bearing checking accounts, but that the introduction of money market accounts shifted both the M2 multiplier and its demand or velocity. The article then assesses the validity of the financial innovations hypothesis by examining whether decisions involving the turnover rate for checkable deposits, currency preferences, money multipliers and M1 and M2 demand or velocity have been affected by these innovations, especially in the manner suggested by the financial innovations hypothesis. The results support the competitive market hypothesis