By Antonio Mele and Radek Stefanski
http://d.repec.org/n?u=RePEc:red:sed017:168&r=dge
Monetary velocity declines as economies grow. We argue that this is due to the process of structural transformation – the shift of workers from agricultural to non-agricultural production associated with rising income. A calibrated, two-sector model of structural transformation with monetary and non-monetary trade accurately generates the long run monetary velocity of the US between 1869 and 2013 as well as the velocity of a panel of 92 countries between 1980 and 2010. Three lessons arise from our analysis: 1) Developments in agriculture, rather than non-agriculture, are key in driving monetary velocity; 2) Inflationary policies are disproportionately more costly in richer than in poorer countries; and 3) Nominal prices and inflation rates are not “always and everywhere a monetary phenomenon”: the composition of output influences money demand and hence the secular trends of price levels.
It is rather well-known that the velocity of money has dramatically declined since the last recession, and the reasons are rather well understood and are largely of temporary nature. This paper made me aware of a larger trend in the decline of velocity, which could explain that velocity should not be getting back to pre-recession levels. How this is explained in the paper, though, is not too convincing for a modern economy: the agricultural sector is non-monetary, and as its importance in the economy shrinks, money velocity declines. Agriculture has been small already for some time in developed economies, and a further decline is not going to noticeably matter, and the sector is largely monetized by now.
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Thanks for the comments and for taking the time to read our paper!
Wevindeed focuses on what happens to monetary velocity when poor countries become rich- rather than when rich countries become richer still. A very interesting extension would be to think seriously about what causes money demand to vary between rich countries and whether (or at least to what extent) an economy’s sectoral composition could explain the very low velocities observed in some very rich countries. Many rich countries however, have money shares (equivalently, inverse money velocities) that are greater than 100%. This leads us to think that compositional issues aren’t going to be as important drivers of velocity differences between rich countries as they are between rich and poor countries. Instead, we think that there must be some aspects of rich economies that work as money multipliers- perhaps specific features of trade or advanced banking sectors- that act to increase the demand for money.
The message from our paper however is that when it comes to velocity differences between rich and poor countries, agricultural productivity is key.
That doesn’t explain the change in Vt during a countries’ advanced industrialization. And your formula and variables are wrong: “The price level in an economy, P, is defined as P ≡ ( M/Y ) V where M is the money stock, Y is output and V is velocity.”
AD doesn’t = PY. AD = M*Vt. & M*Vt = P*T.
The transactions velocity of money (income velocity is a contrived metric), money actually exchanging counter-parties, simply falls as more money becomes idled within the framework of the payment’s system. This is due to the deregulation of interest rates for the commercial bankers (beginning with the 5 successive rate hikes from 1957-1965 that initially caused stagflation), and then the DIDMCA (which turned 38,000 non-banks into commercial banks), the FDIC’s unlimited transaction deposit insurance, and the remuneration of IBDDs, etc.
It is a fact that every time a commercial bank buys securities from, or makes loans to, the non-bank public, it creates new money, demand deposits, somewhere in the payment’s system. Thus, the DFIs do not loan out existing deposits, saved or otherwise. Unless their owners spend/invest their funds directly, or indirectly via non-bank conduits, said savings are lost to both investment and consumption. And un-used / un-spent savings exert an economic drag and decay, in N-gDp and therefore CAPEX, and therefore productivity.
And we knew this already: In 1931 a commission was established on Member Bank Reserve Requirements. The commission completed their recommendations after a 7 year inquiry on Feb. 5, 1938. The study was entitled “Member Bank Reserve Requirements — Analysis of Committee Proposal” It’s 2nd proposal: “Requirements against debits to deposits”
http://bit.ly/1A9bYH1