Saturday, April 18, 2009
Velocity of Money Since 1960
John Maynard Keynes predicted that the nominal interest rate would determine how much liquidity one would demand. At higher interest rates, consumers would hold less cash. How has the introduction of debit cards and the use of credit cards changed this liquidity preference? People now hold less cash. Many buy all of their purchases with a credit card and make one payment at the end of the month. Many just go to the ATM machine when they need cash. Since there is less cash being held by the public, it makes sense that cash has to be spent more times to buy a nominal output. In the graph, this is what I show. I used the mean nominal GDP and mean M1 to calculated the velocity. Velocity equals nominal income divided by the M1. The M1 is composed of currency held by the public, money in checking accounts and money in traveler's checks. The next step is to prove the nominal interest rate determines the demand for money.