Title: Determinants of the velocity of money, the case of Romanian economy
1Determinants of the velocity of money, the case
of Romanian economy
- Dissertation Paper
- Student Moinescu Bogdan
- Supervisor Phd. Professor Moisa Altar
2Goals
- 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)
3Determinants 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
- Bordo and Jonung (1987, 1990) institutional
factor
- Barnett and Xu (1998) - money demand
perspective
4Determinants of money velocity in Romania
- 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
5Institutional 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
6The evolution of M1 and M2 velocity
7The computation of M1 and M2 velocity index
- velocity_bft,i velocity_bft-1,i
velocity_montht,i -
8Methodology, Data and Econometric estimates
- 1. The role of money velocity in the success of
monetary policy program
9Methodological issues (1)
10Variables of equation (1)Time series
199601-200203
11Unit-root test (1)
- intercept
trend and intercept
12Equation (1) estimates
13Actual, Fitted and Residual Graph
14Residual tests Normality test
15Residual tests - Correlogram
16Stability Tests
17Conclusion (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.
18Methodology, 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
19Data 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
20Variables of equation (3)Time series
199601-200203
- All variables are indices (base dec. 1995)
21Velocity of M1, Ex.rate Joint graphs
22Unit-root test (3)
- intercept
trend and intercept
23VAR 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
24Cointegration test (3)
- The cointegration test was performed using
one centred seasonal dummy in order to avoid the
seasonal increases of monetary aggregates in
December.
25VEC estimates
- The exclusion test provide evidence that
exogenity cannot be rejected for these
determinants.
26Variance decomposition of transactions velocity
9
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22
12
- The variables are ordered in the following
sequence output, exchange rate , deposit rate
and income velocity of M1.
27Conclusions (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.
28Methodology, 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.
29Data 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
30Variables of equation (4)Time series
199601-200203
31Unit-root test (4)
32Econometric estimates, equation (4)
33Actual, Fitted and Residual Graph(4)
34Residual tests Normality test
35Residual tests - Correlogram
36Stability Tests
37Stability Tests
38Conclusions (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.
39Final 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.
40Final 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.