The Response Of Financial And Goods Markets To Velocity

It is commonly thought that interest rates should decrease in response to a positive velocity innovation. Velocity innovations, therefore, should lead to the same qualitative effects in the financial and goods markets as money supply innovations. The present paper represents an empirical investigation of the above theoretical statements. By using structural Vector Autoregression (VAR) methods, the responses of interest rates, equity prices, consumer prices and output to velocity and money supply innovations are assessed for the United States. The empirical results do not seem to confirm the traditional analysis. In fact, money supply and velocity innovations seem to affect financial markets in opposite directions. While it is observed that money supply innovations cause interest rates to decrease, a certain amount of evidence is presented suggesting that velocity innovations are responsible for interest rate increases. However, both money supply and velocity innovations lead to higher prices and higher output.