Academic journal article Atlantic Economic Journal

Stationary Velocity and the Long-Run Link between Money and Prices

Academic journal article Atlantic Economic Journal

Stationary Velocity and the Long-Run Link between Money and Prices

Article excerpt

The objective of this note is to show that the coexistence of a long-run link between nominal money and prices [J. J. Hallman, R. D. Porter, and D. H. Small, AER, 1991, pp. 841-581 and stationary velocity [R. F. Engle and C. W. J. Granger, Econometrica, 1987, p. 274! critically depends on real income to be stationary. Consider the quantity theory equation

MV = Py, (1)

where M is nominal money, V is the velocity of money, P is the price level, and y is real income. While assuming that velocity is constant or at least stationary, the classical quantity theory predicts the existence of a stable long-run equilibrium relation in which the price level is proportional to nominal money. Given that the existing empirical evidence generally suggests that M and P are nonstationary time series, the empirical implication of the quantity theory assumption that there is a long-run link between nominal money and prices is that log M and log P each have the same order of integration and are also cointegrated such that log (MIP) is stationary. …

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