Leão (2005) has recently proposed a new explanation for the short run variability of the velocity of money based on the changes in the composition of the expenditure that occur along the business cycle. This paper presents further empirical evidence in favour of Leão’s Expenditure Composition Hypothesis, and draws new implications of this hypothesis for monetary policy. We use a VAR model to analyze the determinants of the velocity of both M1 and M3 in the USA. The main conclusion is that increases in the weight of investment and durable consumption in total expenditure raise the velocity of both narrow and broad money. This is in line with the Expenditure Composition Hypothesis. Furthermore, we draw a new implication of this hypothesis for monetary policy. The more a central bank’s decisions on the interest rate respond to money growth, the more volatile economic growth will be. In other words, a monetary policy strategy - like that of the ECB – which puts emphasis on money growth is de-stabilizing.
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Paper provided by Department of Economics at the School of Economics and Management (ISEG), Technical University of Lisbon. in its series Working Papers with number
2007/10.
Length: Date of creation: 2007 Date of revision: Handle: RePEc:ise:isegwp:wp102007
Contact details of provider: Postal: Department of Economics, School of Economics and Management (ISEG), Technical University of Lisbon, Rua do Quelhas 6, 1200-781 LISBON, PORTUGAL Web page: http://www.iseg.utl.pt/departamentos/economia/
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Find related papers by JEL classification: E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
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