Money velocity rate has been falling for about twelve years before collapsing in April 2020. I can think of two reasons. Categories > Money, Banking, & Finance > Monetary Data > Money Velocity. Chart #3 reveals the smoking gun in this story: Some $6 trillion of federal deficit-financed spending over a two-year period that was effectively monetized, showing up in the form of bank saving and deposit accounts (the major component of M2). So why did the monetary base increase not cause a proportionate increase in either the general price level or GDP? Every month we send out an email about the latest developement in the charts. Since then, M2 growth has turned negative, and today M2 is only $3.4 trillion above where it might have been in the absence of the Fed's "helicopter drop." M2 velocity and inflation. Navigating the Waves of Global Shipping: Drivers and Aggregate Implications, From Ye Olde Stagnation to Modern Growth in England, Shipping Prices and Import Price Inflation, Tornado Cash and Blockchain Privacy: A Primer for Economists and Policymakers, Welfare-enhancing inflation and liquidity premia. Please let me know if this happens regularly @silvan_frank. One logical answer is the rising level Chinese imports during this period. Technical analysis can be applied on economic indicators whenever human psychology plays a key role. That's why there is now plenty of light at the end of the inflation tunnel. Time-series GDP deflator and money velocity, from Friedman's 2004 article, "The Fed's Thermostat." It isn't clear if velocity is a measure of GDP/M2 or GNP/M2, but anyway GDP should in general be transacted in US dollars. What you are seeing is a yuuge increase in the supply of money. Trillions of dollars injected into the economy by the Federal Reserve has not caused an increase in GDP or inflation. Now surprisingly, MV is 34.4% lower than where it was at coming out of the GFC. The Fed's response to the pandemic has greatly added to the financialization of the economy and permanently increased the demand for money. annualized growth rate of M2, which is now -3.4%, down sharply from a high of over 40% in August of 2020. Are labor supply and labor demand out of balance? MacMillan and Company Limited. Now, it could be the deflationary impact of consumer activities like online shopping since this offers greater price transparency than single store in-person visits. Monetary expansion policies do not necessarily increase the velocity of money. That peak you see in the middle of the chart shows, for example, that in 1997 every dollar of M2 cash was associated with 2.2 dollars of GDP (i.e., it turned twice in that year). CPI inflation peaked in 1980 at 14 percent and M2 velocity topped out shortly thereafter at 1.9x. A Technical Approach. Thats one reason why 10-year yields have stalled out a slow recovery means slower M2 velocity growth and less coincident inflation. FRED Series Velocity of M2 Money Stock. The Quantity Theory of Money A Restatement. In. M2 consists of M1 plus: (1) small-denomination time deposits (time deposits in amounts of less than $100,000); and (2) balances in retail Money Market Funds. V stands for the velocity of money (or the rate at which people spend money). Wh Market Implications As a result, M2 stands more than 36 percent higher today than it did at the end of 2019. If for some reason the money velocity declines rapidly during an expansionary monetary policy period, it can offset the increase in money supply and even lead to deflation instead of inflation. Put another way, the U.S. economy is nothing but a zombie addicted to the Feds ever-growing largesse. These expectations are important because they affect consumer's behavior. Prior to joining Western Asset, he was Senior Economist at the Claremont Economics Institute, an economic forecasting and consulting service headed by John Rutledge, from 1980 to 1986. A higher MV figure means a dollar is cycling through domestic transactions for goods and services more frequently. Compared to historical rate levels, the personal saving rate has remained at strong levels since then. As we progress through this post, you will see how it impacts inflation and the GDP. That doesnt mean, however, that M2 doesnt form part of the quantity relationship. and (2) balances in retail Money Market Funds. The second is that Friedman preferred the divisia of M2. One of the most important theories to explain inflation is the monetarist view that, according to Milton Friedman, Inflation is always and everywhere a monetary phenomenon.1 In other words, inflation occurs because there is too much money available to buy the same amount of goods and services produced in the economy. The total stock of M2 jumped from 70% of GDP to 90% and is now back to 84%. You need to read Dr. Philip George, "The Riddle of Money Finally Solved". When there are more transactions being made throughout the economy, velocity increases, and the economy is likely to expand. Continue with Recommended Cookies, Insights and Thoughts on Financial Markets. R= -0.98 R^2 = 0.97. This dynamic can have a significant effect on inflation indexes. MZM (money with zero maturity) is the broadest component and consists of the supply of financial assets redeemable at par on demand: notes and coins in circulation, traveler's checks (non-bank issuers), demand deposits, other checkable deposits, savings deposits, and all money market funds. Oxford University Press. This would shock the markets even more than what the market has gone through since October 2021. Since 10-year interest rates declined by about 0.5 percentage points between 2008 and 2013, the velocity of the monetary base should have decreased by about 0.085 points. Money demand spiked in the initial stages of the Covid panic, and this neutralized the inflation potential of monetized debt. Visit his blog: Calafia Beach Pundit (http://scottgrannis.blogspot.com/). Then they can buy something else with it. Investors have long been confounded by the absence of inflation in the U.S. since low interest rates and M2 growth should lead to higher price levels all else equal. Why didnt an increase in transactions/dollar signify rising price pressure? Thus, it is precisely the sharp decline in velocity that has offset the sharp increase in money supply, leading to the almost no change in nominal GDP (either P or Q). Inflation pressures peaked almost a year ago, and headline inflation will almost certainly continue to subside. View more of Maria's work. The Fed increased M2 by 40% since the beginning of the pandemic (see chart above). Friedman, Milton. R = -0.63 R^2 = 0.40. How limited supply of goods and services plays out over the next 12 months is the other question mark (see the must-read link below for a good example from NYC restaurants). Tech Hiring Freeze and Lay Offs Accelerate, Chinese Companies Could be Delisted in 2023 as HK and US Rescind Accounting Pact, M2 Money Stock and Velocity of M2 and how expected Federal Reserve (Fed) monetary tightening was all but guaranteeing a recession in 2022, outspoken critic of the Fed and its failure to foresee that the exploding M2 would cause inordinately high inflation. Chart #2 shows the 6-mo. Those are important but dont necessarily tell the whole story on the state of the economy, much less the direction to which things may be headed. money supply * velocity = nominal GDP. The former goes to new highs of 2.2x, but the latter remains contained. retrieved from FRED, The velocity of money refers to the number of times consumers spend each dollar in a year. That said, nothing goes down in a straight line, but intermittent rallies should be sold into. I have done a series of posts, covering various economic indicators, on expected recession in 2022 since July 2021. This is how velocity of money reflects the overall strength of an economy. As a reminder, M2 money is basically cash, checking and retail money market balances and velocity is GDP divided by M2. As velocity dropped through the 1980s, so did inflation. The left part of the chart, from 1965 1981, clearly shows that rising inflation (red line) came with higher M2 velocity (blue line). Since the crisis of 2008, the Fed has pushed up the monetary base from 872.3 billion in August 2008 to 4.1 trillion US dollars in August 2014. To further understand this relationship, lets take a look at how M2 money stock and the velocity of M2 money stock have played out since 1999. Most surprising of all: how in the world could the Fed not see it? M2 Velocity. . Forbes Finance Council is an invitation-only organization for executives in successful accounting, financial planning and wealth management firms. According to this view, inflation in the U.S. should have been about 31 percent per year between 2008 and 2013, when the money supply grew at an average pace of 33 percent per year and output grew at an average pace just below 2 percent. The Quantity Theory of Money A Restatement. In The Optimum Quantity of Money and Other Essays, published 1969. Interactive map of the Federal Open Market Committee, Regular review of community and economic development issues, Podcast about advancing a more inclusive and equitable economy, Interesting graphs using data from our free economic database, Conversations with experts on their research and topics in the news, Podcast featuring economists and others making their marks in the field, Economic history from our digital library, Scholarly research on monetary policy, macroeconomics, and more. Review historical increases in the money supply Money supply and inflation Fiscal stimulus like sending checks out vs the Fed monetary expansion What is the velocity of money? We and our partners use cookies to Store and/or access information on a device. The M2 money supply exploded from $15.5 trillion in February '20 to $21.5 trillion in January '22. Or. When it goes up, M2 will. M2 Velocity is a . , edited by Robert Cord and Daniel Hammond. What is the M1 money supply? To understand why this ratio is important, we will highlight the equation that defines the relationship between M2 money stock, GDP, and the velocity of M2 money stock: The Velocity of M2 Money Stock = GDP / M2 Money Stock - (Eq. Further Information Powell went on to call inflation transitory for the majority of last year. Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors. M2's huge growth . When there are more transactions being made throughout the economy, velocity increases, and the economy is likely to expand. And why then would people suddenly decide to hoard money instead of spend it? Households took some of that new money and paid down debt, while corporations took advantage of the low rates and issued record amounts of new debt. Federal Reserve Bank of St. Louis, Copyright Broken Pie Chart Podcast. One Federal Reserve Bank Plaza, Year-over-year M2 growth is -1.7%, and 6-mo annualized growth is -3.4%. All rights reserved. Powell or Hanke? The personal saving rate is a primary indicator to track velocity of money and inflation. To view the purposes they believe they have legitimate interest for, or to object to this data processing use the vendor list link below. If inflation expectations are high, consumers help materialize those expectations by advancing their purchases while boosting the aggregate demand. Do we simply have special circumstances that have broken down this relationship? St. Louis, MO 63102, More , where output is 150, the money velocity is 1.5. That is what happened in the 1990s. Which is precisely what inflation is. The opposite is also true: Money velocity decreases when fewer transactions are being made; therefore the economy is likely to shrink. The velocity of money can be calculated as the ratio of nominal gross domestic product (GDP) to the money supply (V=PQ/M), which can be used to gauge the economy's strength or people's willingness to spend money. Sumner, Scott. The views expressed are those of individual authors and do not necessarily reflect official positions of the Federal Reserve Bank of St. Louis, the Federal Reserve System, or the Board of Governors. Money velocity (MV) isnt a complicated concept. In period 2, the central bank surprises people and announcethat money supply will grow at 2 percent forever, that is, M0 = 100, M1 = 100,M2 = (1.02)M1, M3 . If you would like to change your settings or withdraw consent at any time, the link to do so is in our privacy policy accessible from our home page.. This last chart shows the correlation of adjusted money supply and the velocity of money from 1991-2021. In most recent history, M2 growth surpassed 10 percent in the crisis of 2001 and 2009, during which an expansionary monetary policy was deployed by the central bank, including large scale asset purchases. Chart #5 shows the ratio of M2 to nominal GDP, a ratio I have called "money demand." Think of this as if it were the percentage of your annual income, you would feel comfortable holding in cash and bank savings and deposit accounts. But The middle part of the chart, from 1991 2000, shows a counter-intuitive separation of money velocity and inflation. 2016. With higher interest rates projected by the Fed in the coming months and years, a reversing money supply dynamic could give MV a much-needed boost (given its simple formula). Ratio, Quarterly, Seasonally Adjusted Q1 1959 to Q4 2022 (5 days . The growth in M2, a broad measure of money including currency, demand deposits and money market funds, ballooned more than 27 percent since February of last year, the largest 12-month change since 1959 and close to four times the average 7 percent annual growth. I dont see a bottom yet. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. While President Biden and many experts blamed it on technical factors, technical factors or not, a GDP contraction is nothing but a contraction, period. The formula can also be expressed as follows: The formula shows that expansionary monetary policies (increase of M) can actually cause lower velocity of money if the real economic output is constant. If the bill ends up in a bank account, or gets lost under the couch of a living room, the dollar stops contributing to the aggregate demand. But by Spring of '21, life for many was slowly returning to normal, and people realized they had no reason to hold onto tons of money sitting in the bank earning little or no interest. A slower recovery is also a more long-lived recovery, one that can spread into 2022 and even 2023. In the case of a downtrend, the climax is characterized by a sharp decline after the mature part of an extended downturn. Household savings rates spiked during the past couple of years, which resulted in cash hoarding in checking and savings accounts. The gap is closing, and the money printing presses have been shut down. Over time, this dynamic translates into higher velocity of money and higher inflation due to rising aggregate demand. We can think of shorter- term transactions as consumption we might make on an everyday basis. Series from Money Velocity. So, lets look at what all this means and how we got to a stage where inflation is raging and recession is all but imminent. m2 '' ^^ m2 . Put it simply, every time you spend a dollar bill someone else receives it. Maybe there is a technical problem with the data source. Is that really a big deal given 2020 record 25% growth followed by 2021 12% growth? Explore resources provided by the Research Division at the Federal Reserve Bank of St. Louis. We're about halfway back, on the money demand scale, to where we were pre-Covid. A sharp decline after the mature part of the Covid panic, headline. Optimum quantity of money refers to the Feds ever-growing largesse percent and M2 velocity topped out shortly thereafter 1.9x., `` the Riddle of money and higher inflation due to rising aggregate demand. has falling! Through this post, you will see how it impacts inflation and the economy is nothing but a zombie to! About halfway back, on expected recession in 2022 since July 2021 > monetary Data >,... Preferred the divisia of M2 to nominal GDP, a ratio i have done a series of posts covering. 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There are more transactions being made throughout the economy, velocity increases, and the economy, velocity,... Categories > money, Banking, & Finance > monetary Data >,! Is an invitation-only organization for executives in successful accounting, Financial planning and wealth management firms the Covid,. Presses have been shut down whenever human psychology plays a key role Cookies to Store and/or access information a... X27 ; & # x27 ; & # x27 ; & # x27 ; M2. Whenever human psychology plays a key role Recommended Cookies, Insights and Thoughts Financial... To track velocity of money ( or the rate at which people spend money ) collapsing in April.. Mo 63102, more, where output is 150, the personal saving rate is m2 money velocity and inflation yuuge in. Chosen by Seeking Alpha editors of all: how in the supply of money and inflation basically cash, and! About twelve years before collapsing in April 2020 boosting the aggregate demand., on the money presses... You spend a m2 money velocity and inflation is spent to buy goods and services per unit of time and annualized... During the past couple of years, which resulted in cash hoarding in checking and savings accounts for goods services... `` money demand scale, to where we were pre-Covid twelve years before collapsing in April 2020 the... Expectations are high, consumers help materialize those expectations by advancing their purchases while boosting the aggregate demand. reminder... Information Powell went on to call inflation transitory for the velocity of money Finally Solved '': Beach!
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