Money-driven general equilibrium models with great difficulty are capable to explain the variability on velocity observed in the data, due to the insufficient propagation mechanisms associated with monetary shocks. Alas, a proper assessment on the variability of consumption velocity of money is fundamental to understanding the role of money in the business cycle and bestows insight on the microfoundations of monetary policy.
Attempting to answer for a significant allotment of its variability, financial frictions are introduced in the information structure of a cash-in-advance (CIA) dynamic stochastic general equilibrium model with the interest of studying the impact on velocity of serially correlated monetary shocks. On the proposed modeling environment, at each period the agent is required to make its choice on real money holdings prior to the realization of a monetary shock. Uncertainty regarding the current period’s realization of the money growth rate incentives the agent to carry additional units of cash than those that would be chosen if instead the portfolio is to be formed ex-post the realization of the shock. Frictions on the information structure accentuate a precautionary demand for money balances, causing variability in velocity. On the model, velocity variability will occur more succinctly at low rates of money growth for consumption smoothing purposes, on these cases the agent chooses to hold money for the next period because of expectations of future low realizations of the growth rate.
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If there is anything that is clear from development economics literature over the last two decades it is this: credit markets matter. From Stiglitz and Wiess (1981) to Banerjee and Duflo (2002), both theory and evidence have shown that credit markets are not perfect problems of moral hazard, adverse selection, and contract enforcement lead to credit rationing. Countries, people, or regions that can make credit markets more efficient have benefited and will continue to benefit from a higher GDP.
Beck, Demirguc-Kunt, and Levine (2000) compare financial markets in developed countries to those in developing countries, revealing that economies grow faster, industries depending on external finance expand at higher rates, new firms are created more easily, and firms grow more rapidly in economies with higher levels of overall financial sector development and in countries where legal systems more effectively protect the rights of outside investors.
