Why does the velocity of money move pro-cyclically?

Author: LEÃO, PEDRO

Source: International Review of Applied Economics, Volume 19, Number 1, January 2005 , pp. 119-135(17)

Publisher: Routledge, part of the Taylor & Francis Group

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Abstract:

The velocity of money usually rises in expansions and falls in recessions This paper explains this pro-cyclical movement of velocity using two ideas: (i) during business cycles the movement of investment and consumption of durable goods has a larger amplitude than consumption of non-durable goods and services; (ii) the velocity associated with expenditure on investment and durable goods is much higher than the velocity associated with consumption of non-durable goods and services, because the former expenditures are synchronized with the attainment of money by economic agents whereas the latter are not. In this setting, the rise in the weight of expenditure in durable goods relative to the weight of non-durable goods and services, which occurs during expansions, generates an increase in the average velocity of circulation. The opposite happens during recessions and thus velocity moves pro-cyclically.

Keywords: Velocity of money; money demand; business cycle; monetary policy; endogenous money

Document Type: Research article

DOI: http://dx.doi.org/10.1080/0269217042000312641

Affiliations: 1: Instituto Superior de Economia e Gestao, Technical University of Lisbon, Portugal

Publication date: 2005-01-01

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