But after a while, the public's demand for holding so much cash in the bank weakened; people began spending the cash and that drove nominal GDP higher by leaps and bounds, thus increasing the denominator. We can think of shorter- term transactions as consumption we might make on an everyday basis. Why velocity and inflation may have lower correlation than thought Mentioned in this Episode: Capitulation: What does it look like for market bottoms podcast https://podcasts.apple.com/us/podcast/capitulation-markets-tend-to-lead-the-economy/id1432836154?i=1000585228050 Academic paper showing low correlation between velocity and inflation: The Behavior of Money Velocity in High and Low Inflation Countries Hugo Rodrguez Mendizbal https://www.jstor.org/stable/3839075 Crypto Crash | US Dollar is the thing to watch podcast https://podcasts.apple.com/us/podcast/crypto-crash-us-dollar-is-the-thing-to-watch/id1432836154?i=1000586009794 Derek Moores book Broken Pie Chart https://www.amazon.com/Broken-Pie-Chart-Investment-Portfolio/dp/1787435547/ref=sr_1_1?keywords=broken+pie+chart&qid=1558722226&s=books&sr=1-1-catcorr Contact Derek derek.moore@zegafinancial.com. So why did the monetary base increase not cause a proportionate increase in either the general price level or GDP? If the velocity of money is increasing, then more transactions are occurring between individuals in an economy. m2 '' ^^ m2 . Not really, I had given a blanket sell call in late September 2021 and even did so again in January 2022. Reverse repos explain the surge in M1 relative to M2 in the lead chart. Federal Reserve Bank of St. Louis, Units: Manage Settings For this reason, the charts cannot be displayed. Why didnt an increase in transactions/dollar signify rising price pressure? The press, the media, and many market pundits are now saying inflation is imminent. Friedman, Milton. Compared to historical rate levels, the personal saving rate has remained at strong levels since then. You need to read Dr. Philip George, "The Riddle of Money Finally Solved". Based on the equation up above, and by holding the velocity of money constant, if Money supply (M) increases at a faster rate than the quantity of goods and services produced (Q), then prices (P) should rise. Seasonally adjusted M2 is constructed by summing savings deposits (before May 2020), small-denomination time deposits, and retail MMFs, each seasonally adjusted separately, and adding this result to seasonally adjusted M1. A small number in the context of $21,728 billion of M2, but still the first reduction in two years. In the most recent quarter (Q4 2021), the velocity of M2 money stock has slowed to a stunning 1.123. Amazon Return To Office Mandate, And Whats Happening With Amazon Stock? The frequency of currency exchange can be used to determine the velocity of a given component of the money supply, providing some insight into whether consumers and businesses are saving or spending their money. Everything's Endogenous., Barnett, William A. M2 increase of 20% to GDP followed by 5 years of 5% inflation. While M2 velocity is currently at historical lows, inflation is clearly not high. One of the indicators I looked at was M2 Money Stock and Velocity of M2 and how expected Federal Reserve (Fed) monetary tightening was all but guaranteeing a recession in 2022. Money velocity (MV) isnt a complicated concept. That is what happened in the 1990s. It can be thought of as the rate of turnover in the money supply--that is, the number of times one dollar is used to purchase final goods and services included in GDP. Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors. 1). This blog offers commentary, analysis and data from our economists and experts. Then, why velocity of money may not mean anything for inflation after all. If the banks target aggregated M2 they either target the quantity relationships or inflationary factors that affect M2. How this graph was created: Search FRED for "M2 Money Velocity" and choose the series "Velocity of M2 Money Stock", or M2V. Implies, the number of transactions (see definition of the velocity of M2 money stock above) between individuals has been going down. Data in this graph are copyrighted. Historically, M2 has grown along with the economy (see in the chart below). Further Information A possible answer lies in the combination of two issues: In this regard, the unconventional monetary policy has reinforced the recession by stimulating the private sectors money demand through pursuing an excessively low interest rate policy (i.e., the zero-interest rate policy).3. A glooming economy after the financial crisis, The dramatic decrease in interest rates that has forced investors to readjust their portfolios toward liquid money and away from interest-bearing assets such as government bonds. annualized growth rate of M2, which is now -3.4%, down sharply from a high of over 40% in August of 2020. M2's huge growth from 2020 through 2021 provided the fuel for the inflation that has rocked the economy for the past year, and it's great news that it's fading away. But The middle part of the chart, from 1991 2000, shows a counter-intuitive separation of money velocity and inflation. 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. 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. Two, velocity plays a large factor in the relationship: If Americans quickly turn their cash savings and money market fund balances into trips, shopping excursions and service-based experiences like dining out then M2 velocity will accelerate quickly and inflation should logically follow. Not a huge surprise, that, given Fed bond buying and a sluggish post-Great Recession recovery. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. 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. The contraction of the velocity of circulation of money explains why the massive increase of the monetary base by the American central bank has not led to a price inflation. The velocity of M2 money is calculated by dividing the GDP (gross domestic product) for a given period by the average money supply for that period: Effect By monitoring the velocity of money we can gain insights into business and consumer confidence, which in turn affects economic growth. The velocity of money is the frequency at which one unit of currency is used to purchase domestically- produced goods and services within a given time period. Now surprisingly, MV is 34.4% lower than where it was at coming out of the GFC. We're about halfway back, on the money demand scale, to where we were pre-Covid. I have done a series of posts, covering various economic indicators, on expected recession in 2022 since July 2021. Household savings rates spiked during the past couple of years, which resulted in cash hoarding in checking and savings accounts. Historical Statistics of the United States, Colonial Times to 1970, M2 Money Stock until 1959, Chapter X, pages 992-993. Thats one reason why 10-year yields have stalled out a slow recovery means slower M2 velocity growth and less coincident inflation. This dynamic can have a huge impact on inflation. Charts powered by Highcharts. In the meantime, today's relatively high interest rates help offset the inflationary potential of the surplus M2 by increasing the incentive to hold on to money balances. Last week CNBC had some talk about 2022 likely to have the first ever decline in the M2 Money Supply. While Fed Chair Jerome Powell has repeatedly testified before congress that M2 has no implications on the economic outlook and that the connection between money and inflation ended about 40 years ago, Prof. Hanke has continued to highlight that is absolutely not true. High money velocity is usually associated with a healthy, expanding economy. Or. 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. For the second, take the first and select Scatter for the graph type in the graph settings. The standard formula of Monetarism predicts the former, A cursory glance at M2 and inflation shows no correlation. One would say, who could have seen this? Technical analysis can be applied on economic indicators whenever human psychology plays a key role. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. https://fred.stlouisfed.org/series/M2V, Supply also matters here, and that issue tips in favor of higher prices for items like new cars and trucks. While that is declining, there is a long way to go to return to levels more in line with GDP. Low money velocity is usually associated with recessions and contractions. At first this was fine, because the public was not willing or able to spend itthe demand for money was intense. MacMillan and Company Limited. 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. Is that really a big deal given 2020 record 25% growth followed by 2021 12% growth? Report. Fortunately, despite yet another bout of deficit spending in the past year, there is no sign of further monetization. Which is precisely what inflation is. Before May 2020, M2 consists of M1 plus (1) savings deposits (including money market deposit accounts); (2) small-denomination time deposits (time deposits in amounts of less than $100,000) less individual retirement account (IRA) and Keogh balances at depository institutions; and (3) balances in retail money market funds (MMFs) less IRA and 5 (1980): 10051014. Such an unprecedented increase in money demand has slowed down the velocity of money, as the figure below shows. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. 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. 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. Forbes Finance Council is an invitation-only organization for executives in successful accounting, financial planning and wealth management firms. Barnett, William A. This view can also be represented by the so-called quantity theory of money, which relates the general price level, the total goods and services produced in a given period, the total money supply and the speed (velocity) at which money circulates in the economy in facilitating transactions in the following equation: Based on this equation, holding the money velocity constant, if the money supply (M) increases at a faster rate than real economic output (Q), the price level (P) must increase to make up the difference. 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