Income-Velocity of Money in Agricultural Developing Economies

Abstract

T HE response of income-velocity of money to economic growth has implications for monetary planning in a developing economy. Velocity is the ratio of nominal income to money stock and decreases only if money stock rises at a faster rate than nominal income. A well-known hypothesis in this context is that of Friedman (1959) which states that ... in countries experiencing a secular rise in real income per capita, the stock of money generally rises over long periods at a decidedly higher rate than does money i.e., velocity declines. Ezekiel and Adekunle (1969) and Melitz and Correa (1970), in their international crosscountry comparisons, have found evidence largely in favour of the Friedman hypothesis. This, in its turn, has strengthened the hope for active growthoriented monetary planning-the extent of resources that can be transferred for investment purposes through non-inflationary monetary expansion increases as development proceeds.' Cross-section studies involving developed and developing economies do not provide satisfactory indications of what happens to velocity over time in any individual developing economy. Firstly, velocities have not behaved uniformly in all the developing economies. Secondly, international cross-country comparisons do not adequately explain why velocity changes in any individual economy. Is it because money is a luxury good (i.e., income-elasticity of demand for money is greater than unity) to the agents in the economy? Is it because economic development brings about structural changes in the economy which lead to the observed behaviour of velocity? Is it because monetary habits change in a systematic way? It is important to have time-series analyses of developing economies to provide answers to such questions. For example, in a study of Malaysia and Singapore, Short (1973) found that though velocity did move inversely to per capita income, this negative impact ... was overpowered by the change in monetary habits which the increase in bank offices caused... . The aim of this paper is to analyse the temporal behaviour of income-velocity of money in agricultural developing economies. In the literature on velocity and demand for money in developing economies, attention is focussed mainly on three issues: (i) the incomeelasticity of demand for money and in particular whether money is a luxury good or not; (ii) the growth of monetisation and changes in monetary habits, and (iii) the effect of the cost of holding money. One important factor which has suffered total neglect is the role of sectoral differences in money demand behaviour and the structural shifts in the sectoral composition of income that accompany development. Money demand behaviour may vary across sectors. This is true not only in developing economies but also in developed economies. For example, Goldfeld (1976) has found that the business sector and the household sector in the United States have different money demand functions. An implicit specification error is committed in the aggregative money demand or velocity equation whenever the sectoral-income-composition factor is omitted. On a priori grounds this factor should have special significance in developing economies where sectoral shares in national income change over time. In the absence of flow-offunds accounts and adequate data on sectoral money holdings for most of the developing economies, direct estimation of sectoral demand functions is not possible. Thus, an aggregative specification which incorporates the sectoral-income-composition factor is necessary to analyse the behaviour of velocity.