FEDERAL RESERVE BANK OF ST. LOUIS
Velocities of GNP and GDFD
fered another variant of the specification problem. They too argue that the demand for mone is based on
expenditures instead of current income or CNP. in
their view, the 1980 tax cut initially increased disposa- ble personal and business income relative to GNPand,
hence, raised desired expenditures relatiye to GNP; consequently, the tax cut increased the demand for money, resulting in a fall in velocity.’
One way to evaluate this explanation is to look at the ratio of disposable personal income to GNP. if their’
explanation is valid, this r-atio should incr’ease when velocity-is falling and decrease when velocity is rising. As char-t 4 indicates, however, this has riot gener-ally
happened during the l980s. While there was an initial expansion in disposable income following the tax cut,
the ratio of disposable income to GNP has generally declined since 1982.s
‘Recently. McGibany and Nourzad (1986) have provided estimates indicating that the demand for money is inversely related to the
taverage tax rate. Rasche (forthcoming) rejects the tax cut hypothesis by arguing that,
for it to explain the velocity decline, marginal tax rates ~ouldhave had to have fallen continuously over the 1 980s.
Others have argued that the recent velocity decline is related to a sharp rise in financial transactions
r’elative to total output. According to this view, the Iise in financial transactions caused an increase in the
demand for- money relative to GNP. One way to assess this claim is to compare velocity measures using
broad measures of financial and non-financial trans- actions in place of GNP? These alternatives ar-c pre- sented in chart 5. The non-financial transactions ve- locity measur’e shows the same pattern as the GNP velocity measur’e. Consequently, explanations of the velocity puzzle that rely on the recent slowing of GNP growth relative to the growth of more general non- financial tr’ansactions measures at-c implausible.
The financial transactions velocity measur’e does not show the downturn in the 1980s that char-acterizes the non-financial and GNP-based velocity measures. Nor’, however, does it show substantial incr’eases dur- ing the 1980s which would be required if the rse in financial transactions is to account for the decline in Ml velocity. tn fact, the annual growth rate of the financial transactions velocity measure has averaged
~Thesedata were obtained from the Board of Governors of the Federal Reserve System.