WHAT DRIVES MOVEMENTS IN THE INCOME VELOCITY OF MONEY? A CASE STUDY OF THE U.S.

Keywords: Income Velocity of Money, Financialization, Interest Rates.

Abstract

In their efforts to stabilize the price level, central banks often rely on the growth rate in the stock of money as an intermediate target variable. Usually, the premise underlying this approach is that the income velocity of money, defined as the ratio of nominal GDP to the stock of money, either randomly fluctuates around a constant mean or can, at least, be predicted with sufficient accuracy. The purpose of this paper is to put this assumption to the test. We do so by applying a first-order autoregressive model, supplemented by a set of lagged exogenous regressors, to the quarterly changes in velocity in the U.S. Our results confirm previous findings that dynamic dependencies exist between changes in the income velocity of money over successive periods of time. They also support the assertion that rising long-term interest rates lower the demand for money. Perhaps most importantly, however, we find that all else being equal, the degree of financialization in the economy, measured by the ratio of financial assets to GDP, has a positive and statistically significant effect on velocity. A possible explanation of this finding is the increasing availability of tradable, non-monetary financial instruments that are close substitutes for bank deposits.

JEL Classification Codes: E41, E43, E51.

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Published
2023-12-17
How to Cite
Khatun, M., & Siddiqui, S. (2023). WHAT DRIVES MOVEMENTS IN THE INCOME VELOCITY OF MONEY? A CASE STUDY OF THE U.S. American Finance & Banking Review, 8(1), 14-20. https://doi.org/10.46281/amfbr.v8i1.2149
Section
Research Paper/Theoretical Paper/Review Paper/Short Communication Paper