FEDERAL RESERVE BANK OF ST. LOUIS
Velocities of GNP/M~Aand Permanent Income/M1A
general pattern of exchange rate movements is the same whether the nominal or real exchange rate is
following that event is consistent with a gradual ad- justment to the initial and subsequent innovations
Chart 14 shows that the exchange rate explanation does not provide a satisfactory answer to the velocity puzzle. From 1973 to 1981, exchange rate movements appear to have no influence on velocity. While velocity did decline from 1981 to 1983, when the exchange rate was rising, it also fell sharply in 1985 and 1986 when the exchange rate was plummeting.
TWO EXPLANATIONS MAY BE BE1TER THAN ONE
Darby, Mascaro and Marlow 1987) have recently suggested that the velocity puzzle of the l980s is a product of financial innovation and cyclical effects in measured velocity. Incorporating both effectsr chart 15 compares the usual velocity measure with a measure derived by dividing permanent income by MM. There is a sharp rise in the permanent income/MIA velocity measure beginning with the nationwide introduction of NOW accounts, The movement in this measure
that increased the cost of holding M1A, such as the introduction of Super NOWs in January 1984 and the
reduction of the minimum balance requirements on these accounts in January 1985.
The permnanent income/M1A velocity measure, un- like virtually all velocity measures shown in the pre- vious charts, does not decline during the bulk of the 1980s. This measure does not decline until the last three quarters of 1986; however, it turns up again during the first half of 1987. Darby, Mascaro and Marlow suggest that the 1986 decline can be explained by the extremely rapid MIA growth during the last three quarters of the year. Consequently, a combina- tion of the effects of financial innovations, cyclical movements in GNP and sharp acceleration in M1A growth could account for much of the velocity puzzle of the 1980s.
SUMMARY AND CONCLUSIONS
This article reviews a number of suggested explana- tions of the puzzling downturn in Ml velocity during