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Money Velocity with Interest Rate Stochastic Volatility and Exact Aggregation

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  • William Barnett

    (Department of Economics, The University of Kansas)

  • Haiyang Xu

    (Washington University in St.Louis)

Abstract

The determinants of money velocity are theoretically explored under various assumptions of interest rate uncertainty in a monetary general equilibrium model. Money is introduced by putting monetary services in the utility function. Monetary assets pay interest. When interest rates are uncertain, it is found that the degree of risk aversion in consumers' preferences and the risk in the return rates of the benchmark asset affect both the intercept and slope of the money velocity function, while the risk in return rates of monetary assets only affects the intercept of the money velocity function. The traditional money velocity function would become unstable if covariances change over time between interest rates and consumption growth rate or between interest rates and real money growth rate. We simulate the model developed in this paper and find that the coefficients of the money velocity function are volatile. The Swamy and Tinsley (1980) random coefficient model is then estimated with money velocity data to compare the results with those from model simulation. It is found that the estimated stochastic slope coefficient of the velocity function behaves in a manner that is approximately consistent with the simulation results.

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Paper provided by University of Kansas, Department of Economics in its series WORKING PAPERS SERIES IN THEORETICAL AND APPLIED ECONOMICS with number 201224.

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Length: 24 pages
Date of creation: Sep 2012
Date of revision: Sep 2012
Handle: RePEc:kan:wpaper:201224

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  1. Belongia, Michael T, 1996. "Measurement Matters: Recent Results from Monetary Economics Reexamined," Journal of Political Economy, University of Chicago Press, vol. 104(5), pages 1065-83, October.
  2. Giovannini, Alberto & Labadie, Pamela, 1991. "Asset Prices and Interest Rates in Cash-in-Advance Models," Journal of Political Economy, University of Chicago Press, vol. 99(6), pages 1215-51, December.
  3. Barnett, William A & Fisher, Douglas & Serletis, Apostolos, 1992. "Consumer Theory and the Demand for Money," Journal of Economic Literature, American Economic Association, vol. 30(4), pages 2086-2119, December.
  4. Swamy, P. A. V. B. & Tinsley, P. A., 1980. "Linear prediction and estimation methods for regression models with stationary stochastic coefficients," Journal of Econometrics, Elsevier, vol. 12(2), pages 103-142, February.
  5. Michael T. Belongia, 1984. "Money growth variability and GNP," Review, Federal Reserve Bank of St. Louis, issue Apr, pages 23-31.
  6. Pamela Labadie, 1989. "Stochastic inflation and the equity premium," Discussion Paper / Institute for Empirical Macroeconomics 12, Federal Reserve Bank of Minneapolis.
  7. James B. Bullard, 1994. "Measures of money and the quantity theory," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 19-30.
  8. Barnett, William A., 1980. "Economic monetary aggregates an application of index number and aggregation theory," Journal of Econometrics, Elsevier, vol. 14(1), pages 11-48, September.
  9. Fisher, Douglas & Serletis, Apostolos, 1989. "Velocity and the growth of money in the United States, 1970-1985," Journal of Macroeconomics, Elsevier, vol. 11(3), pages 323-332.
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