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Velocity of money and inflation dynamics

There have been large changes in the velocity of money which could be a potential source of inflation variability. This article investigates how the velocity of money affects inflation dynamics by estimating the Phillips curve derived from a New Keynesian model in which money is introduced via transactions technology. The resultant Phillips curve becomes a function of velocity as well as an output gap and a forward looking inflation terms, a feature for which we provide empirical support. Specifically, we adopt the GMM methodology to estimate the velocity-augmented forward looking Phillips curve using the US data between 1951 and 2005. We observe that historical inflation dynamics is consistent with the view.