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Money Velocity and the Natural Rate of Interest

Luca Benati ()

Diskussionsschriften from Universitaet Bern, Departement Volkswirtschaft

Abstract: Since World War I, M1 velocity has been, to a close approximation, the permanent component of the short-term nominal rate. This logically implies that, under monetary regimes which cause inflation to be I(0), permanent fluctuations in M1 velocity uniquely reflect, to a close approximation, permanent shifts in the natural rate of interest. Evidence from the Euro area and several inflation-targeting countries is compatible with this notion, with velocity fluctuations being systematically strongly correlated with a Stock and Watson (1996, 1998) estimate of trend real GDP growth. I exploit this insight to estimate the natural rate of interest for the United Kingdom and Canada under inflation targeting: In either country, the natural rate has been consistently declining since the early 1990s.

Keywords: Money demand; Lucas critique; structural VARs; unit roots; cointegration; long-run restrictions: natural rate of interest. (search for similar items in EconPapers)
Date: 2017-06
New Economics Papers: this item is included in nep-his, nep-mac and nep-mon
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