Demand for money

In 1987 Michael Bordo and I published The Long-Run Behavior of Velocity. The International Evidence (Cambridge University Press). There we presented evidence that the income velocity of money for five countries for which we had good data - the United States, Canada, the United Kingdom, Sweden and Norway - displayed a U-shaped pattern from the 1870s to the 1970s. Velocity went through three stages: first it declined, then it fluctuated around a fairly flat section, and finally it rose. Next, we developed and tested an explanation for this long run pattern, emphasizing the role of institutional variables. We hypothesized that the decline was due to a process of monetization, whereby the growth in the demand for money outpaced that of real income, thus inducing a fall in velocity. The rise was attributed to financial sophistication, the development of close substitutes for money, and to improved economic security and stability. The turning point, that is the low point of the velocity curve, marks the phase where these two institutional forces roughly balance each other.

In our empirical work we found support for the institutional approach based on four types of evidence: (i) an econometric study of the long-run velocity function for the five countries for which we had adequate data, (ii) a case study of the monetization process in Sweden prior to 1914, (iii) a cross-section study of about 80 countries in the post-World War II period, and (iv) an examination of the time series properties of velocity.

In this reprint Demand for Money (Transaction Publishers 2003) we add a new introduction where we first track the evolution of velocity in the last quarter of the 20th century in the same way as in our original book which examined the evidence up until the mid-1970s. Next, we discuss how the views of the economics profession on money demand have developed since the 1970s. In short, this is a story of money disappearing from the research agenda. Finally, we consider the circumstances under which money, and thus velocity, may make a return in the future similar to its revival in the 1960s and 1970s. Can we predict a new cycle of interest in velocity in theoretical and empirical work?

You can download the introduction here:
Introduction to "Demand for money"