FEDERAL RESERVE BANK OF ST. LOUIS
Velocities of GNP/M1 and GNP/Currency
relatively unresponsive to interest rate movements.
This could be mitigated by the fact that
to have been
r’ates on these to adjust to
CYCLICAL EXPLANATIONS OF THE VELOCITY PUZZLE
suggests that interest rates
the relationship between should have strengthened
since the financial innovations of the 1980s. Indeed, this pattern is reflected in Chart 11, which shows Ml
velocity and the three-month Treasury bill rate. Prior to 1981, velocity appears to be unrelated to move- ments in the T-bill r’ate. Since 1981, however, the two
have similar patterns. This is consistent with a nutn- ber of studies which report an increased interest sen-
sitivity of Ml balances during the 1980s.” (Additional analysis is provided in the appendix.) It remains to be
Until now, we have assumed implicitly that the supply of money passively expands to meet society’s
demand. Another interpretation argues that substan- tial exogenous changes in the supply ofMl can induce cyclical swings in measured velocity because of their lagged effect on the economy. Forexample, an accelen’- ation in the gr-owth rate of Ml initially may produce a less than proportionate rise in the level of nominal GNP, and, thus, an initial decline in velocity. Eventu- ally, however, when the monetary change has worked
its way thr’oughout the economy fully, the longer-run relationship between Ml growth and the rate of
seen whether the apparent change in Ml’s interest sensitivity alone can account for the aberrant behavior
of Ml velocity.
spending is reestablished, and velocity returns to its long-run path.
“For example, Hetzel (1987), Trehan and Walsh (1987) and Rasche (1986). Rasche reports mixed results and concludes that this argu- ment needs further study and analysis.
This analysis can explain a continuous fall in veloc- ity relative to its underlying trend only if Ml growth is
continuously accelerating. The “ever-and-ever-faster Ml growth” explanation for the velocity decline in the