Efficiency of the Payments System, Velocity of Circulation of Money, and Financial Markets

The paper presents a general equilibrium monetary production model to illustrate the influence of unexpected changes in the efficiency of the payments system on the velocity of circulation of money and on the financial markets, in the presence of uncertainty. In this model, households face a cash-in-advance constraint and use a part of current income for present consumption. The results depend critically on the magnitude of the changes in the payment process relative to the monetary injections in the economy. If such changes are small, then the velocity of money is exogenously determined by the level of efficiency of the payments system. Moreover, the financial markets are affected by unexpected changes both in the money supply and in the velocity of money. In contrast, if the relative changes in the payment process are large, then the velocity of money is endogenously determined by households' decisions regarding cash-holding, lending, consumption, and labor. Moreover, it appears that the financial markets are affected only by changes in the rate of growth of money. EFFICIENCY OF THE PAYMENTS SYSTEM, VELOCITY OF CIRCULATION OF MONEY, AND FINANCIAL MARKETS* by Flavio Padrini Ministry of the Treasury, Italy First draft: May 1995 This draft: November 1996 * The opinions expressed in this paper are those of the author and do not necessarily represent the views of the Italian Ministry of the Treasury. I am indebted to Behzad Diba for encouragement and guidance during countless meetings, and to Matthew Canzoneri for suggestions and stimulating discussions. Thanks to Riccardo Fiorito, Pamela Labadie, and Chul Woo Park for comments, and to seminar participants at Georgetown University and at the Conference on "Payment Systems Research and Public Policy: Risk, Efficiency, and Innovation", sponsored by the Board of Governors of the Federal Reserve System and by the Journal of Money, Credit, and Banking, Washington D.C., 7-8 December 1995. All the remaining errors are mine.