Monetary Disequilibrium in Developing Countries: Estimation Using a Structural VAR Approach

This paper introduces a new application for structural vector autoregression methodology in applying the technique to identifying money velocity gaps for a sample of developing countries. SVAR methodology using long-run restrictions is used to construct money-velocity gaps for a large sample of developing countries. Variance decomposition is used to examine the nature of the shocks to money velocity and impulse response functions are used to examine the nature of the adjustment process. The results suggest that most of the observed shifts in money velocity in developing countries are due to the effects of permanent shocks that may be associated with factors such as financial development and reform. Transitory shifts in velocity around the equilibrium path appear to reflect temporary money shocks that cause temporary disequilibrium in money holdings which dissipate over time as prices adjust. The results are consistent with price stickiness combined with substantial inflation inertia, and financial market imperfections and rigidities that are common in developing countries.