Stochastic trends in the long-run behavior of velocity: A new test of the institutional hypothesis

The institutional approach to the long-run behavior of velocity has been implemented through testing whether proxy variables for the process of monetization, the spread of commercial banking, the level of financial sophistication, and economic stability are related to movements in velocity. In this paper I argue that a valid test of this type requires that a distinction is made between trends and temporary fluctuations in velocity and the institutional proxies. When this distinction is taken into account, it appears that the long-run behavior of velocity is less easily explained by the institutional variables than previous tests suggested.