FEDERAL RESERVE BANK OF ST. LOUIS
Short-Run and Trend Growth of Ml
Ratio 18 —
4 It II II
1~~~~~II Il I
e l I r i n i
l i i , ‘ ~ 4 : r~ ,.çNt~t’ II I
II ‘ ~,
~ I II I I I I I S h o r t - r u n J \ ~ ~ ~ ‘ 2 \ ~ v t ~ ~ ~ / 2 ~ L I ‘ I , 9 :1 !llremrd ~ it /I I I I ‘ p I I ‘ ~ I ~ ~j ‘/~‘ I v i 6 3
tions have fallen over’ the past five years, they must have done so for non-monetary reasons; as char-t 2
the rise in the real exchange value of the dollar during the early 1980s made holding dollars relatively more
shows, trend Ml growth has risen rapidly since 1983. These non-monetary factors must have been suf-
attractive, increasing the demand for money relative to income and reducing velocity.” Since the real ex-
ficiently powerful to have swamped the usual in- fluence that rapid trend money growth has on in- flation and imeflationary expectations.
change value of the dollar has generally moved with changes in the U.S. inflation rate, this argument is closely related to the inflation am’gument.
Furthermore, if disinflation and declining nominal interest rates caused velocity to decline, then, by the same argument, velocity should have risen shar’ply when inflation accelerated and nominal interest n’ates rose during the 1970s. Unfortunately, this is not the case. Chart 13 shows MI-velocity and the e~post inflation rate. While velocity moves with the inflation rate after 1981, it does not appear to be affected sub- stantially by the inflation rate over the pre-financial- innovations period. Velocity growth during the 1970s is not rapid enough to support this explanation.
This explanation is examined in chart 14, which shows the movements in velocity and the nominal trade-weighted exchange rate since 1973. The nominal rather than the real exchange rate is used for two reasons. First, movements in the nominal exchange
rate are more appropriate in assessing the relative returns on two different monies. Second, movements
in the nominal and real trade-weighted exchange rates have been highly correlated since 1973. Thus, the
Hetzel and Mehra 1l985i suggest that the demand
for money balances varies positively with the real value of the dollar in foreign exchange markets. Their’
explanation is based on the currency-substitution hy-
pothesis, which states that different currencies are close substitutes for each other. In this explanation,
“Thisargument does not seem firmly based in either the transactions or asset approaches to the demand for money. Except for some border situations, there is very limited substitutability between two currencies for transactions purposes. On the other hand, money balances, even interest-bearing checking accounts, are dominated on a risk-adjusted return criterion by other non-money assets.
Consequently, it is unlikely that foreign money is held as an asset in portfolios.