Velocity effects of increased variability in monetary growth in Egypt: A test of Friedman's velocity hypothesis

Abstract

This paper tests Friedman's hypothesis that increased variability in the growth of money supply causes velocity to decline, using Egyptian data from the period 1960-99. The monetary aggregates M1 and M2 are decomposed into anticipated and unanticipated components and the variability of money growth is computed as the standard deviation of five years of monetary growth rates. Cointegration tests show that there is a statistically significant long-run relationship between the variability in money growth and velocity, for both M1 and M2. However, while increased variability in the growth of M2 is found to be associated with lower velocity - supporting Friedman's velocity hypothesis - increased variability in the growth of M1 seems to have no influence on velocity, possibly because the definition of M1 has changed over time. The findings also suggest that anticipated movements in M2 volatility are not neutral, in the sense that they do affect velocity. An important implication is that the scope for discretionary monetary policy in Egypt is somewhat circumscribed in the short run. However, if the Central Bank of Egypt were to make its decisions more transparent and pre-announce its policies, then velocity would be more predictable and monetary policy more potent. © African Development Bank 2004.