MishkinCh19 supplementary velocity 110408

MishkinCh19 supplementary velocity 110408 - and...

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Is velocity constant? 1. Classicals thought V constant because didn t have good data 2. After Great Depression, economists realized velocity far from constant 3. Velocity actually falls, or at least its rate of growth declines, in years when recessions are taking place.
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Keynes’s Liquidity Preference Theory Interest rates are procyclical, rising in expansions and falling in recessions. The liquidity theory indicates that a rise in interest rates will cause velocity to rise also. Since V = Y / f (i ,Y) i , f( i,Y ) , V The procyclical movements of interest rates should induce procyclical movements in velocity.
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3 Differences between Keynes’s
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Unformatted text preview: and Friedman’s Model (cont’d) The demand for money is stable ⇒ velocity is predictable • Md / P = f( Y P ) ; V = Y / f( Y P ) • In a business cycle expansion, much of the increase in income will be transitory, permanent income (Yp) rises much less than income (Y). • As a result, Y rises by more than f(Yp) and V increases. • The opposite happens in a business cycle contraction Y falls by more than f(Yp). • Therefore V is procyclical – rises in a business cycle expansion and falls in a business cycle contraction. • Money is the primary determinant of aggregate spending...
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