Income velocity and the variability of money growth: evidence from less developed countries

Abstract

This paper examines whether the variability of money growth caused changes in income velocity of money in 30 less developed countries. Time-series data show year-to-year variations in income velocity of money in these countries for the 1961-1990 period. Empirical results based on causality but complemented by variance decomposition tests show that money growth is the most important determinant in explaining the variability in income velocity in at least 20 of the 30 developing countries examined in this study. In addition, the causality results show that inflation rate Granger-causes income velocity of money in 21 countries, but the variance decomposition results show inflation rate to be relatively more important in explaining the variability of velocity in eight countries. Similarly, while real income Granger-causes velocity of money in 18 countries, the results of the variance decomposition tests show real income to be relatively more important as a determinant of income velocity in two countries. Overall, these results show that the Grangercausality as a test of predictability does not show the effects of shocks to one variable on another, but the variance decomposition test provides evidence with respect to the effects of shocks.