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FEDERAL RESERVE BANK OF ST. LOUIS

AUGUST/SEPTEMBER 1967

dhart 8

Velocities of Monetary Indexes MO, MSI 1 and Ml

Ratio 1.7

Quarnerly Oata

Rotio 1.7

1.6

1.6

1.5

1.5

1.4

‘.4

1.3

1.3

1.2

1.2

1.1

1.1

1.0

1.0

.9

12 1970 71 N O T E , D a t a n o r m a l i z e d n 1 - , t q u a r t e r 1 9 7 0 = 1 13 . 74 75 76

77

18

79

80

81

82

83

84

85

86

1981

.9

STRUCTURAL SHIFTS AND THE VELOCITY PUZZLE

different structural shift argument, see shaded inser’t on the opposite page.

Some analysts have suggested that there have been one on’ mor’e sttttctural shifts in the money/income r’elationslup. tJnlike the specification pr’ohlems previ- ously discussed, this explanation presumes that the fundamental r’elationship hetween money and in- come has changed even if the demand for money is correctly specified in terms of Ml and CNP.” For a

Financial Innovation and Deregulation

Several analysts have suggested that the introduc- tion of NO%’Vs, Super- NOWs and money market deposit accounts )MMDAs) and the removal of regulation Q interest rate ceilings in recent years have pr’oduced a

shift in the relationships between Ml and both spend- ing and inflation. In particular, the redefinition of Ml

to include interest-bearing checkable deposits (NOWs and Super- NOW5I as well as non-interest-bearing de-

“One structural shift argument not considered explicitly in the text was presented recently byRoley (1985). He suggested that the

velocity puzzle of the 1980s was actually caused by the well- documented, albeit still unexplained, structural shift in the demand

mand deposits and currency is alleged to have altered

significantly its “moneyness;” now Ml is presumed to include a significant amount of savings balances,”

for money that took place in 1974. He argues that the downward shift in velocity in the 1982—83 period is consistent with the behavior

of Ml velocity from 1974 through 1981; it is inconsistent, however, with Ml velocity before 1974. Roley’s observation does not solve

Consequently, changes in Ml resulting from changes in these savings balances are likely to have a smaller

the velocity puzzle—although about 13 years have passed, we still don’t know why money demand shifted in the mid-1970s.

Furthermore, if his suggestion were valid, the mid-l970s’ velocity

increase should have been as dramatic as its drop in the 1980s. A glance at chart 1 shows that this is not the case. Moreover, Roley’s Ml series was derived from the flow of funds accounts, When

conventional money stock and money demand equations are used instead, his results are not confirmed.

“The reader should note the similarity between this and the specifica- tion problem. The argument here is that savings balances are now effectively hidden among transactions balances so that a given level

of interest-bearing checking account balances effectively can repre- sent different amounts of “transactions money.” This is a specifica’ tion problem, and results from a fundamental change in the institu- tional structure.

14

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