Velocity of money and inflation dynamics

Abstract

There have been large changes in the velocity of money which could be a potential source of inflation variability. This article investigates how the velocity of money affects inflation dynamics by estimating the Phillips curve derived from a New Keynesian model in which money is introduced via transactions technology. The resultant Phillips curve becomes a function of velocity as well as an output gap and a forward looking inflation terms, a feature for which we provide empirical support. Specifically, we adopt the GMM methodology to estimate the velocity-augmented forward looking Phillips curve using the US data between 1951 and 2005. We observe that historical inflation dynamics is consistent with the view.

Acknowledgements

We thank comments from Ken West, John Williams Peter Ireland, Young Sik Kim, Jinill Kim, Junggun Oh, Hyun Eui Kim and other participants in the Bank of Korea-KAEA conference and WEAI conference. Usual disclaimer applies.

Notes

¹ We checked with Breuch–Pagan test, White test and others to find out that heteroskedasticity exists in a standard regression analysis of our model.