Financial Frictions and Money-Driven Variability in Velocity

Frictions are introduced in the information structure of a cash-in-advance dynamic stochastic general equilibrium model with the interest of studying the impact of serially correlated monetary shocks on the variability of velocity. Possessing no analytical solution this dynamic environment, a projection method which parameterizes expectations and employs finite elements in the approximation of the system’s policy functions is proposed, thoroughly developed and employed on the solution for the equilibrium of the economy. The algorithm is able to effi ciently handle the occasionally binding cash-in-advance constraint on transactions, permitting an analysis on the variability of velocity. It is concluded that frictions on the information and financial structure of the economy accentuate a precautionary demand for money balances, increasing the incidence of adjustments on the velocity of transactions as an answer to money growth rate shocks, with the purpose of smoothing consumption.