The Effects of Disinflationary Policies on Monetary Velocity

Is the recent decline in monetary velocity the result of deregulation or disinflation? Studies of this issue using recent U.S. data generally attribute the decline to deregulation. We examine the experience in the United States back to 1907 and the recent experience, the past 30 years, in a group of 39 countries. Our results show a systematic relation between unexpected changes in the money-income relationship and changes in the trends of inflation rates.

By our calculations, a policy that reduced average inflation by 10 percentage points from one business cycle to the next would be associated with an average 3 to 5 percentage-point reduction in velocity growth trends. This effect is somewhat smaller than the U.S. record for the 1980s, especially for MI. We do not offer these results as a method for adjusting monetary targets during a disinflation; rather, our results offer further evidence that the failure to commit to a stable price policy tends to destabilize the economy.