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Precautionary Balances and the Velocity of Circulation of Money

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  • Miquel Faig
  • Belén Jerez

Abstract

The low velocity of circulation of money implies that households hold more money than they normally spend. This behavior is explained if households face uncertain expenditure needs, so that they have a precautionary motive for holding money. We investigate this motive in a search model where households are subject to preference shocks. The model predicts that the velocity is not only low but also interest elastic. The model closely fits United States data on velocity and interest rates (1892-2004). The empirical analysis reveals a dramatic reduction in precautionary balances towards the end of our sample, which is important for policy issues.

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Bibliographic Info

Paper provided by University of Toronto, Department of Economics in its series Working Papers with number tecipa-188.

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Length: 37 pages
Date of creation: 31 Mar 2006
Date of revision:
Handle: RePEc:tor:tecipa:tecipa-188

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Keywords: Precautionary Balances; Monetary Search; Velocity of Circulation of Money; Money Demand.;

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References

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  1. Hodrick, Robert J & Kocherlakota, Narayana R & Lucas, Deborah, 1991. "The Variability of Velocity in Cash-in-Advance Models," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 358-84, April.
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  3. Robert E. Lucas, Jr. & Nancy L. Stokey, 1987. "Money and Interest in a Cash-in-Advance Economy," NBER Working Papers 1618, National Bureau of Economic Research, Inc.
  4. Faig, Miquel & Jerez, Belen, 2005. "A theory of commerce," Journal of Economic Theory, Elsevier, vol. 122(1), pages 60-99, May.
  5. Guillaume Rocheteau & Randall Wright, 2003. "Money in Search Equilibrium, in Competitive Equilibrium, and in Competitive Search Equilibrium," PIER Working Paper Archive 03-031, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  6. Miquel Faig, 2004. "Divisible Money in an Economy with Villages," Levine's Bibliography 122247000000000159, UCLA Department of Economics.
  7. John W. Kendrick, 1961. "Productivity Trends in the United States," NBER Books, National Bureau of Economic Research, Inc, number kend61-1.
  8. Ricardo Lagos & Randall Wright, 2002. "A unified framework for monetary theory and policy analysis," Working Paper 0211, Federal Reserve Bank of Cleveland.
  9. Aleksander Berentsen & Gabriele Camera, 2004. "Money, Credit, and Banking," 2004 Meeting Papers 473, Society for Economic Dynamics.
  10. Shouyong Shi, 1997. "A Divisible Search Model of Fiat Money," Econometrica, Econometric Society, vol. 65(1), pages 75-102, January.
  11. Moen, Espen R, 1997. "Competitive Search Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 385-411, April.
  12. Svensson, Lars E O, 1985. "Money and Asset Prices in a Cash-in-Advance Economy," Journal of Political Economy, University of Chicago Press, vol. 93(5), pages 919-44, October.
  13. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, vol. 68(2), pages 247-274, March.
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Cited by:
  1. Rojas Breu, Mariana, 2013. "The welfare effect of access to credit," Economics Papers from University Paris Dauphine 123456789/7353, Paris Dauphine University.
  2. Belen Jerez & Miquel Faig, 2005. "Inflation, Prices, and Information in Competitive Search," 2005 Meeting Papers 462, Society for Economic Dynamics.
  3. Telyukova, Irina A. & Visschers, Ludo, 2009. "Precautionary Demand for Money in a Monetary Business Cycle Model," MPRA Paper 15622, University Library of Munich, Germany.
  4. Telyukova, Irina A. & Visschers, Ludo, 2013. "Precautionary money demand in a business-cycle model," Journal of Monetary Economics, Elsevier, vol. 60(8), pages 900-916.
  5. Thomas Straubhaar & Henning Vöpel, 2012. "Euro- und Finanzkrise: Sollte die EZB ihre Aufgabe über die Inflationsbekämpfung hinaus erweitern?," Ifo Schnelldienst, Ifo Institute for Economic Research at the University of Munich, vol. 65(02), pages 04-07, 01.
  6. Zhe Li & Miquel Faig, 2007. "The Welfare Cost of Expected and Unexpected Inflation," 2007 Meeting Papers 125, Society for Economic Dynamics.
  7. Mei Dong, 2011. "Money and Costly Credit," Working Papers 11-7, Bank of Canada.
  8. Mei Dong, 2009. "Money and Costly Credit," 2009 Meeting Papers 404, Society for Economic Dynamics.
  9. Fusaro, Marc Anthony, 2010. "Are "bounced check loans" really loans? Theory, evidence and policy," The Quarterly Review of Economics and Finance, Elsevier, vol. 50(4), pages 492-500, November.
  10. Aleksander Berentsen & Samuel Huber & Alessandro Marchesiani, 2014. "Financial innovations, money demand, and the welfare cost of inflation," ECON - Working Papers 136, Department of Economics - University of Zurich.
  11. Jacky Mallett & Charles Keen, 2012. "Does GDP measure growth in the economy or simply growth in the money supply?," Papers 1208.0642, arXiv.org.
  12. Ludo Visschers & Irina A. Telyukova, 2009. "Precautionary Demand for Money in a Monetary Search Business Cycle Model," 2009 Meeting Papers 410, Society for Economic Dynamics.

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