Determinants of the velocity of money, the case of Romanian economy

1
Determinants of the velocity of money, the case
of Romanian economy

• Dissertation Paper
• Student Moinescu Bogdan
• Supervisor Phd. Professor Moisa Altar

2
Goals

• To identify the real and monetary factors, which
  affect velocity of money

• To measure the extent of each determinants
  influence on the variability of money velocity

• using the Johansens cointegration procedure
  for the velocity of M1 (transactions velocity)
• using a dynamic equation for the velocity of M2
  (velocity of circulation)

3
Determinants of money velocity A review of
literature

• Irving Fisher (1911) expected inflation
• Whendepreciation is anticipated, there is a
  tendency among owners of money to spend it
  speedilythe result being to raise prices by
  increasing the transactions velocity

• Milton Friedman (1956)

• Bordo and Jonung (1987, 1990) institutional
  factor

• Barnett and Xu (1998) - money demand
  perspective

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Determinants of money velocity in Romania

• Output

• Exchange Rate

• Deposit Rate

• Spread of commercial banking

• Confidence in national currency
• the opportunity of saving money through term
  deposits versus holding USD
• inflation deviation from its targeted level

5
Institutional factors

• the abolition of the consumption rationalization
  system

• the development of banking system

• the liberalization of the exchange market

• the improvement of the institutional framework
  of monetary policy

6
The evolution of M1 and M2 velocity
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The computation of M1 and M2 velocity index

• velocity_bft,i velocity_bft-1,i
  velocity_montht,i

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Methodology, Data and Econometric estimates

• 1. The role of money velocity in the success of
  monetary policy program

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Methodological issues (1)

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Variables of equation (1)Time series
199601-200203
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Unit-root test (1)

• intercept
  trend and intercept

12
Equation (1) estimates
13
Actual, Fitted and Residual Graph
14
Residual tests Normality test
15
Residual tests - Correlogram
16
Stability Tests
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Conclusion (1)

• Wald test is performed in order to test
  whether changes of velocity are significant for
  the success of monetary policy

The econometric evidence points out the role of
money velocity in driving inflation away from its
targeted level.
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Methodology, Data and Econometric estimates

• 2. Determinants of the velocity of M1

OBJ. - to separate the real from monetary
causes and to estimate the importance of each
from these factors on the transaction velocity
variability
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Data issues (3)

• Short data series
• Necessary data availability
• industrial output index as a proxy for GDP
  dynamic
• the exchange rate (ROL/USD) was considered as
  proxy for the opportunity of holding foreign
  currencies
• average interest paid on deposits was considered
  as opportunity cost for transaction money
• Unconvincing information provided by data

20
Variables of equation (3)Time series
199601-200203

• All variables are indices (base dec. 1995)

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Velocity of M1, Ex.rate Joint graphs
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Unit-root test (3)

• intercept
  trend and intercept

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VAR Lag Order Selection Criteria

• The number of lags used to perform the
  cointegration test and to estimate the error
  correction vector (VEC) is determined using the
  following criterion

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Cointegration test (3)

• The cointegration test was performed using
  one centred seasonal dummy in order to avoid the
  seasonal increases of monetary aggregates in
  December.

25
VEC estimates

• The exclusion test provide evidence that
  exogenity cannot be rejected for these
  determinants.

26
Variance decomposition of transactions velocity
9
57
22
12

• The variables are ordered in the following
  sequence output, exchange rate , deposit rate
  and income velocity of M1.

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Conclusions (3)

• First, exchange rate is the most important
  determinant of income velocity of M1

• Second, both real and monetary factors are
  important in explaining movements in transactions
  velocity.

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Methodology, Data and Econometric estimates

• 3. Determinants of the velocity of M2
• OBJ. - to measure and to test the stability of
  the sensitivity of income velocity of M2 to
  changes of confidence in national currency.
  Moreover, it will be analysed the role of
  commercial banking in explaining movements in
  velocity of circulation.

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Data issues (4)

• There is no available data about the confidence
  in national currency, but its evolution could be
  expressed through

• changes of inflation deviation from its
  targeted level

• the opportunity of saving money through term
  deposits versus holding USD

30
Variables of equation (4)Time series
199601-200203
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Unit-root test (4)
32
Econometric estimates, equation (4)
33
Actual, Fitted and Residual Graph(4)
34
Residual tests Normality test
35
Residual tests - Correlogram
36
Stability Tests
37
Stability Tests
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Conclusions (3)

• Equation (4) does quite a reasonable job of
  explaining the dynamic of M2 velocity (R2 0.77)

• The confidence in the national currency is an
  important determinant of income velocity of M2.

• The deregulation of exchange rate market in
  1997 had a major impact on the function of the
  velocity of money.

• The sensitivity of velocity of circulation to
  the confidence in national currency is quite
  stable since 1997.

• The improvement of Romanians banking system
  soundness reduced the contribution of banks to
  velocity instability.

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Final remarks

• The role of velocity variability in driving
  inflation away from its targeted level is
  confirmed by empirical results

• The main finding of the paper is that
  velocity fluctuations are less influenced by
  output variability and governed by the exchange
  rate, deposit rate and expectations about the
  outcome of monetary policy, in a sound banking
  environment.

40
Final remarks

• This result represents the first step for a
  future analysis about the controllability of the
  velocity instability using monetary instruments.

• Adding various structural factors in the way
  Bordo and Jonung (1987) suggest (e.g. including
  financial innovations and other deepening
  variables) would affect the variance
  decomposition of the velocity of M1 and the
  stability of the velocity of M2 function.