Behavioral Pattern of Income Velocity of Money and Estimation of Its Function (The case of Iran)

10.22059/ier.2004.30910

Abstract

Based on the “Aggregate Demand” theory, monetary policies are designed with the aim of achieving desirable level of macroeconomic goals through affecting the stock of money supplyand income velocity of money. Thus, the velocity (V)-as well as money supply - has significant impact, particularly on rate of inflation through expansionary or contractionary monetary policy. To focus on the velocity from a theoretical point of view, the classical theories of demand for money considered this variable as a stable, due to negligible changes in structures and real variables of the economy. On the other hand, the contemporary theories of New-classical and New-Keynesian schools believed in the effectiveness of anticipated and even unanticipated policies on the fluctuations, or stability of income velocity. However in regards to the fluctuations of this variable in the Iranian economy, it has been observed that from the 1340’s (1960’s) until the beginning of the First Five Year Development Plan, in 1368 (covering 1989/90-1993/94 period) it has diminished and then until recent years, it has an upward trend, showing a “U” shape pattern, same as that in the European and American economies. Thus, to find a specific behavioral pattern for this variable, we can estimate and predict its impacts on macroeconomic variables, i.e, on inflation rate, etc. In this paper, an attempt is made to survey the stability of this variable, and then the long run or the equilibrium function of income velocity shall be estimated, using the co-integration method. Finally, we analyse the short run adjustment of this variable to predict its long-run equilibrium value, by applying the impulse response function, variance decomposition and error correction model (ECM).

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