By Antonio Mele and Radek Stefanski
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.