IDEAS home Printed from
   My bibliography  Save this paper

The 1981-82 Velocity Decline: A Structural Shift in Income or Money Demand?


  • Robert J. Gordon


The velocity of both M1 and M2 appears to have experienced a sharp and persistent downward shift during 1981 and 1982. The implications of this shift are reexamined within the context of the previous literature on quarterly econometric equations explaining the demand for money. The traditional specification of money demand equations popularized by Chow and Goldfeld relates real balances to output, interest rates,and lagged real balances, all expressed as log levels. A consistent finding has been a large coefficient on the lagged dependent variable.While this has been interpreted as indicating substantial adjustment costs in portfolio behavior, it is also consistent with lags or"inertia" in price adjustment due to the presence of long-term wage and price contracts. The fact that the traditional Chow-Goldfeld money demand specification encountered large post-sample prediction errors at the time of the first oil shock in 1973-75 may suggest that a new interpretation of adjustment costs is required. It may be costly to adjust nominal balances by shifting to alternative assets, but it is costless for agents to allow real balances to shrink in response to an unanticipated price shock, as in 1973-75. A substantial amount of evidence is provided on the relationship between money, income, and interest rates, using alternative dynamic specifications. The post-1973 prediction error in a demand equation for M1 is reduced by three-quarters when the equation is specified in nominal first-difference form rather than in the form of real levels in logs. Results indicate much smaller post-1979 prediction errors for equations describing "simple-sum" M2 than for simple-sum M1, Divisia M1,or for Divisia M2 measures of the money supply.

Suggested Citation

  • Robert J. Gordon, 1984. "The 1981-82 Velocity Decline: A Structural Shift in Income or Money Demand?," NBER Working Papers 1343, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:1343
    Note: EFG

    Download full text from publisher

    File URL:
    Download Restriction: no

    References listed on IDEAS

    1. Laidler, David, 1980. "The demand for money in the United States-- Yet again," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 12(1), pages 219-271, January.
    2. Fama, Eugene F, 1975. "Short-Term Interest Rates as Predictors of Inflation," American Economic Review, American Economic Association, vol. 65(3), pages 269-282, June.
    3. Granger, C. W. J. & Newbold, P., 1974. "Spurious regressions in econometrics," Journal of Econometrics, Elsevier, vol. 2(2), pages 111-120, July.
    4. Robert J. Gordon, 1983. "Using Monetary Control to Dampen the Business Cycle: A New Set of First Principles," NBER Working Papers 1210, National Bureau of Economic Research, Inc.
    5. Stephen M. Goldfeld, 1973. "The Demand for Money Revisited," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 4(3), pages 577-646.
    Full references (including those not matched with items on IDEAS)


    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.

    Cited by:

    1. V. Vance Roley, 1985. "Money Demand Predictability," NBER Working Papers 1580, National Bureau of Economic Research, Inc.
    2. Subramanian S Sriram, 1999. "Survey of Literature on Demand for Money; Theoretical and Empirical Work with Special Reference to Error-Correction Models," IMF Working Papers 99/64, International Monetary Fund.
    3. Werner, Richard A., 2012. "Towards a new research programme on ‘banking and the economy’ — Implications of the Quantity Theory of Credit for the prevention and resolution of banking and debt crises," International Review of Financial Analysis, Elsevier, vol. 25(C), pages 1-17.
    4. Chen, Yi-Ting, 2006. "Non-nested tests for competing U.S. narrow money demand functions," Economic Modelling, Elsevier, vol. 23(2), pages 339-363, March.

    More about this item


    Access and download statistics


    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:1343. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: () or (Joanne Lustig). General contact details of provider: .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.