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Precautionary Balances and the Velocity of Circulation of Money

Author

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  • Miquel Faig

    () (Department of Economics University of Toronto)

  • Belen 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 (1892-2003). The empirical analysis reveals a dramatic reduction in precautionary balances towards the end of our sample, which is important for policy issues

Suggested Citation

  • Miquel Faig & Belen Jerez, 2006. "Precautionary Balances and the Velocity of Circulation of Money," 2006 Meeting Papers 457, Society for Economic Dynamics.
  • Handle: RePEc:red:sed006:457
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    References listed on IDEAS

    as
    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 358-384, April.
    2. Miquel Faig, 2004. "Divisible Money in an Economy with Villages," Levine's Bibliography 122247000000000159, UCLA Department of Economics.
    3. Ricardo Lagos & Randall Wright, 2005. "A Unified Framework for Monetary Theory and Policy Analysis," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 463-484, June.
    4. Kiyotaki, Nobuhiro & Wright, Randall, 1989. "On Money as a Medium of Exchange," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 927-954, August.
    5. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, vol. 68(2), pages 247-274, March.
    6. Lucas, Robert E, Jr & Stokey, Nancy L, 1987. "Money and Interest in a Cash-in-Advance Economy," Econometrica, Econometric Society, vol. 55(3), pages 491-513, May.
    7. Berentsen, Aleksander & Camera, Gabriele & Waller, Christopher, 2007. "Money, credit and banking," Journal of Economic Theory, Elsevier, vol. 135(1), pages 171-195, July.
    8. Moen, Espen R, 1997. "Competitive Search Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 385-411, April.
    9. Guillaume Rocheteau & Randall Wright, 2005. "Money in Search Equilibrium, in Competitive Equilibrium, and in Competitive Search Equilibrium," Econometrica, Econometric Society, vol. 73(1), pages 175-202, January.
    10. John W. Kendrick, 1961. "Productivity Trends in the United States," NBER Books, National Bureau of Economic Research, Inc, number kend61-1, December.
    11. Shouyong Shi, 1997. "A Divisible Search Model of Fiat Money," Econometrica, Econometric Society, vol. 65(1), pages 75-102, January.
    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 919-944, October.
    13. Faig, Miquel & Jerez, Belen, 2005. "A theory of commerce," Journal of Economic Theory, Elsevier, vol. 122(1), pages 60-99, May.
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    Citations

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    Cited by:

    1. Thomas Straubhaar & Henning Vöpel, 2012. "Euro- und Finanzkrise: Sollte die EZB ihre Aufgabe über die Inflationsbekämpfung hinaus erweitern?," ifo Schnelldienst, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 65(02), pages 04-07, January.
    2. 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.
    3. Faig Miquel & Jerez Belén, 2006. "Inflation, Prices, and Information in Competitive Search," The B.E. Journal of Macroeconomics, De Gruyter, vol. 6(1), pages 1-34, September.
    4. repec:mbr:jmonec:v:11:y:2016:i:2:p:173-191 is not listed on IDEAS
    5. Telyukova, Irina A. & Visschers, Ludo, 2009. "Precautionary Demand for Money in a Monetary Business Cycle Model," MPRA Paper 15622, University Library of Munich, Germany.
    6. repec:eee:dyncon:v:90:y:2018:i:c:p:208-219 is not listed on IDEAS
    7. Aleksander Berentsen & Samuel Huber & Alessandro Marchesiani, 2018. "Limited Commitment and the Demand for Money," Economic Journal, Royal Economic Society, vol. 128(610), pages 1128-1156, May.
    8. Mei Dong, 2009. "Money and Costly Credit," 2009 Meeting Papers 404, Society for Economic Dynamics.
    9. Ashley, Richard & Verbrugge, Randal, 2015. "Persistence Dependence in Empirical Relations: The Velocity of Money," Working Paper 1530, Federal Reserve Bank of Cleveland.
    10. Faig, Miquel & Li, Zhe, 2009. "The welfare costs of expected and unexpected inflation," Journal of Monetary Economics, Elsevier, vol. 56(7), pages 1004-1013, October.
    11. Aleksander Berentsen & Samuel Huber & Alessandro Marchesiani, 2015. "Financial Innovations, Money Demand, and the Welfare Cost of Inflation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 47(S2), pages 223-261, June.
    12. Randall Wright & Philipp Kircher & Benoit Julîen & Veronica Guerrieri, 2017. "Directed Search: A Guided Tour," NBER Working Papers 23884, National Bureau of Economic Research, Inc.
    13. Huangfu Stella, 2009. "Competitive Search Equilibrium with Private Information on Monetary Shocks," The B.E. Journal of Macroeconomics, De Gruyter, vol. 9(1), pages 1-27, March.
    14. Jacky Mallett & Charles Keen, 2012. "Does GDP measure growth in the economy or simply growth in the money supply?," Papers 1208.0642, arXiv.org.
    15. repec:dau:papers:123456789/7353 is not listed on IDEAS
    16. 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.
    17. 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.
    18. Faig, Miquel, 2008. "Endogenous buyer-seller choice and divisible money in search equilibrium," Journal of Economic Theory, Elsevier, vol. 141(1), pages 184-199, July.

    More about this item

    Keywords

    Precautionary Balances; Velocity of Circulation of Money; Demand for Money;

    JEL classification:

    • 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

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