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The behavior of velocity

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Lars Jonung
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In this article we provide evidence from annual data for the period 1880–1986 that institutional variables are significant determinants of velocity in the United States, United Kingdom, Canada, Sweden, and Norway. This evidence supplements our earlier findings (Bordo and Jonung, The Long-run Behavior of the Velocity of Circulation, Cambridge University Press, 1987) for annual data ending in the early 1970s. We present evidence that several proxies for institutional change in the financial sector are significant determinants of the long-run velocity function; that for the majority of countries the long-run velocity function incorporating institutional determinants has not undergone significant change over the last 10–15 years; and that out-of-sample forecasts over the last 10–15 years based on our institutional hypothesis are superior to those based on a benchmark long-run velocity function for a number of countries. These results suggests that failure to account for institutional change in the financial sector such as may be captured by our proxy variables may well be one factor behind the recently documented instability and decline in predictive power of short-run velocity models incorporating dynamic adjustment and higher-frequency data.