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

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

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

Dissertation Paper

Student: Moinescu Bogdan

Supervisor: Phd. Professor Moisă Altăr

Goals economy

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

- To measure the extent of each determinant’s influence on the variability of money velocity

- using the Johansen’s cointegration procedure for the velocity of M1 (transactions velocity)
- using a dynamic equation for the velocity of M2 (velocity of circulation)

Determinants of money velocity – A review of literature economy

- Irving Fisher (1911) – expected inflation
“When…depreciation is anticipated, there is a tendency among owners of money to spend it speedily…the 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

Determinants of money velocity in Romania economy

- 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

Institutional factors economy

- 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

The computation of M1 and M2 velocity index economy

velocity_bft,i = velocity_bft-1,i + velocity_montht,i

Methodology, Data and Econometric estimates economy

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

Methodological issues –(1) economy

Variables of equation (1) economy Time series: 1996:01-2002:03

Unit-root test – (1) economy

intercept trend and intercept

Equation (1) estimates economy

Residual tests – Normality test economy

Residual tests - Correlogram economy

Stability Tests economy

Conclusion (1) economy

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.

Methodology, Data and Econometric estimates economy

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

Data issues – (3) economy

- 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

Variables of equation (3) economy Time series: 1996:01-2002:03

All variables are indices (base dec. 1995)

Unit-root test – (3) economy

intercept trend and intercept

VAR Lag Order Selection Criteria economy

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

Cointegration test – (3) economy

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

VEC estimates economy

The exclusion test provide evidence that exogenity cannot be rejected forthese determinants.

Variance decomposition of transactions velocity economy

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

9%

57%

22%

12%

Conclusions (3) economy

- 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.

Methodology, Data and Econometric estimates economy

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.

Data issues – (4) economy

- 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:

Variables of equation (4) economy Time series: 1996:01-2002:03

Unit-root test – (4) economy

Residual tests – Normality test economy

Residual tests - Correlogram economy

Stability Tests economy

Stability Tests economy

Conclusions – (3) economy

- 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 Romanian’s banking system soundness reduced the contribution of banks to velocity instability.

Final remarks economy

- 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.

Final remarks economy

- 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.

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