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In my macroeconomics class, our professor showed an example of the introduction of the credit card. She says that this will decrease the money people are willing to hold, and thus increase the money velocity. But why is that true? I mean, although it seems like the credit card as a new mean of payment makes us feel we are not holding much money, but the credit card company are actually paying for us them using deposits. So the money people hold didn't actually change because while consumers hold less cash or deposit, banks that offer credit card will need to hold more cash or deposit to pay for it. So I think the claim that money velocity increases is false. Am I right?

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Credit cards are a way of deferring payment in the form of inter-temporal substitution; it helps reduce the household's liquidity constraint that may prevent it from consumption smoothing as much as they would like if their transitory income was much more spread over the household's lifetime.

You are right that the amount of money doesn't change. Loans require giving away money, but credit cards are a way of creating debt, so banks do not need to hold more cash to give a line of credit like you suggest.

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  • $\begingroup$ So is it right to say the money velocity increases? Or decreases? $\endgroup$ – Kun Oct 21 '15 at 19:16
  • $\begingroup$ I'd say it increases. $\endgroup$ – Kitsune Cavalry Oct 21 '15 at 19:23
  • $\begingroup$ And why is that? Why does money changes hands more often in this case. (Let us suppose people spend the same as usual, when they do not have credit card) $\endgroup$ – Kun Oct 21 '15 at 19:27
  • $\begingroup$ 1.) The marginal propensity to consume can increase for each individual consumer (can even be above one). 2.) Credit card companies are taking on the payment process with physical money. -- So with those two things the money velocity would increase. $\endgroup$ – Kitsune Cavalry Oct 21 '15 at 19:56
  • $\begingroup$ But what if Let us suppose people spend the same as usual, when they do not have credit card. Then will there still br an increase in velocity? $\endgroup$ – Kun Oct 21 '15 at 20:19

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