Demand deficiency, money velocity and heterogeneity

Abstract

Aim: Money velocity data for the United States show that there is a decline in all of the broad money aggregates in recent decades. This points to a sustained demand deficiency element. Can consumer heterogeneity be the cause of this declining trend? The aim of this paper is to find an answer for this question.
 
 Design / Research Methods: To achieve our aim we use Agent Based Modelling (ABM). In our model, the agents are heterogeneous consumers with different spending propensities.
 
 Conclusions / findings: We show that heterogeneous consumers with different spending propensities alone puts a downward pressure on money velocity. This pressure is coupled with a sustained worsening in the wealth distribution. We observe that as money accumulates in the hands of agents with the lowest propensity to spend, money velocity keeps declining. This also puts a downward pressure on nominal aggregate demand and hence a deflationary bias on the general price level.
 
 Originality / value of the article: This paper shows that heterogeneity of economic agents should not be ignored and that ABM is a very powerful tool to analyse heterogeneity.
 
 Implications of the research: The implication for policy makers is that the demand deficiency associated with the fall in money velocity will persist until the worsening of wealth dispersion comes to a halt.

Money Growth and Social Stability

“…In Figure 2 above, the trend in concentration of wealth in the top 10 per cent of the population is evident in the US after the end of the 1980s. This is consistent with the fall in velocity of money, as explained in Basci and Gherbi (2020) in a model without money growth. In the current paper, we will argue that the same dynamics prevail if money growth is proportional (regardless of what the rate of money growth is).…”

“…This operational change of making the short term interest rate the main policy instrument of the central bank, coupled with the independence of the Central Bank, opened up a new era of an unprecedented sustained fall in the velocity of broad money. Basci and Gherbi (2020) attempt to explain such a sustained fall in velocity in a model with consumer heterogeneity. Yet in that paper, there is no money growth assumed and the data before 1980 is not addressed.…”

“…The growth rate of broad money supply aggregates has been modest over the decade following the Global Financial Crisis (GFC). This coupled with a several decades long fall in the velocity of money (Basci, Gherbi 2020) seems to have led to a demand deficiency era in most G7 countries (Basci, Basci 2021), until very recently. Yet, following the Covid-19 pandemic shock, the nature of the massive expansionary fiscal, monetary and financial sector policies in especially the United States (English et al 2021;Carroll et al 2021) have the potential to reverse this trend in low nominal demand growth towards a more inflationary one (Blanchard, 2021;Goodhart 2020;Summers 2021).…”