Youll notice the greater correlation and then decoupling. Its possible that a declining MV could have been directly attributed to record low interest rates, which resulted from record high growth of money supply. M1 is the money supply of currency in circulation (notes and coins, traveler's checks [non-bank issuers], demand deposits, and checkable deposits). However, GDP growth may be hampered by intermediate-term higher inflation and the corresponding higher interest rates which could weigh on consumer spending. 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. The consent submitted will only be used for data processing originating from this website. If the velocity of money is increasing, then more transactions are occurring between individuals in an economy. Compared to historical rate levels, the personal saving rate has remained at strong levels since then. LIVE MARKETS Will money velocity be a bigger inflation factor in 2022? Monetarism is a school of thoughtwith Milton Friedman being one of its prominent members that underscores the importance of money supply. This gives you the first graph. March 1, 2023. 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. As velocity dropped through the 1980s, so did inflation. Velocity is a ratio of nominal GDP to a measure of the money supply (M1 or M2). Friedman and Divisia Monetary Measures. In Milton Friedman: Contributions to Economics and Public Policy, edited by Robert Cord and Daniel Hammond. Quarterly. 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. Typically, increasing money velocity leads to higher inflation. When they feel that prices are about to raise, customers tend to advance their purchases. Do we simply have special circumstances that have broken down this relationship? Steve H. Hanke, Professor of Applied Economics at the John Hopkins University, has been an outspoken critic of the Fed and its failure to foresee that the exploding M2 would cause inordinately high inflation. 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. M2's huge growth . Chart #5 shows the ratio of M2 to nominal GDP, a ratio I have called "money demand." A decreasing velocity of M1 might indicate fewer short- term consumption transactions are taking place. Please update to a modern browser: a list is available here. 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. No wholesale; no offshore. The Fed's broadest measure of the money supply, called M2, is more than $21.6 trillion today, up from $15.5 trillion in February 2020. Further Information The answer lies in the private sectors dramatic increase in their willingness to hoard money instead of spend it. How is velocity of money calculated? Case 2. Calculated as the ratio of quarterly nominal GDP to the quarterly average of M2 money stock. How this graph was created: Search FRED for "M2 Money Velocity" and choose the series "Velocity of M2 Money Stock", or M2V. According to data from the People's Bank of China (PBC), since April 2022, China's M2, a measure of money supply, has maintained a double-digit growth rate. , Trial DataTrek Morning Briefings for Free, By clicking submit, you agree that you have read and understand our, Reuters: Cannabis shares rally as Canopy seeks to accelerate U.S. market entry. Why? Or. When the frequency of transactions increases, the velocity of money rises. 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. Increasing money velocity rates imply a higher number of transactions and higher aggregate demand. Low money velocity is usually associated with recessions and contractions. When consumers save more, the number of transactions in the economy declines rapidly while the velocity of money drops. 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. Please disable your ad-blocker and refresh. An increase in time deposits destroys money velocity. 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. Data in this graph are copyrighted. The first signs of this are now on record. 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 M2 for April 2022 is lower by $81.2 billion. According to Bannister and Forward (2002, page 28), Money supply growth and inflation are inexorably linked. Predicting the bottom at this time would be foolhardy. The right side of the equation represents the Gross Domestic product. The total stock of M2 increased from $19.373 trillion at the start of 2021 to a peak of $21.740 trillion in March 2022. 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). The Quantity Theory of Money A Restatement. In. Inflation pressures peaked almost a year ago, and headline inflation will almost certainly continue to subside. No. Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors. Put another way, the U.S. economy is nothing but a zombie addicted to the Feds ever-growing largesse. These put persistent pressure on prices. A declining M2 constitutes deflation. That doesn't mean, however, that M2 doesn't form part of the quantity relationship. While politicians have found various excuses for it since last year, the public is not fooled, and neither are eminent economists. This happened because the nominal interest rate on short-term bonds has declined essentially to zero, and, in this case, the best form of risk-free liquid asset is no longer the short-term government bonds, but money. Releases from Federal Reserve Bank of St. Louis, More I dont see a bottom yet. Reverse repos explain the surge in M1 relative to M2 in the lead chart. Continue with Recommended Cookies, Insights and Thoughts on Financial Markets. The Fed has seriously distorted money supply. Q stands for the quantity of goods and services produced. We see 3 things going on here: Money, no matter how much may be in the system, doesnt translate into inflation if it just sits in the bank collecting dust. GDP = M2 Money Stock * The Velocity of M2 Money Stock - (Eq. Expertise from Forbes Councils members, operated under license. One Federal Reserve Bank Plaza, 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.. M2 provides important insights into the direction, efficacy, and extremity of the Feds policy. View more of Maria's work. So, who would you believe? 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 this happening to you frequently? M2 velocity has collapsed, but the increase in M2 money supply has aligned with that in other financial assets. Please be sure to comment, debate and let me know where you think the dollar goes next. Please enter your email address or username below. It is still mind-boggling to me that the unprecedented growth of M2 has almost completely escaped the public's notice. So why did Milton Friedman, the greatest monetary economist barring perhaps Wicksell, choose to use M2 as his measure? Ratio, Quarterly, Seasonally Adjusted Q1 1959 to Q4 2022 (5 days . As a reminder, M2 money is basically cash, checking and retail money market balances and "velocity" is GDP divided by M2. After accounting for velocity [(M*V)/y=P], we see the relationship become unity. Are you sure you want to remove this series from the graph? What is the M2 money supply? And why then would people suddenly decide to hoard money instead of spend it? Ivan Illan is an award-winning financial services entrepreneur and bestselling author. Consider M1, the narrowest component. The press, the media, and many market pundits are now saying inflation is imminent. 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. Now surprisingly, MV is 34.4% lower than where it was at coming out of the GFC. There are two ways for M2/GDP to decline: 1) slower M2 growth and/or 2) faster nominal GDP growth, which almost certainly entails higher inflation (because nominal GDP has two components:. We dont yet know if or how that will alter inflation trends. In other words, MZM money is M2 money minus time deposits. https://www.econlib.org/archives/2015/10/everythings_end.html. During the Great Financial Crisis (GFC), MV went from a high of 1.989 at the GFCs start in Q3 2007 to a low of 1.712 by end of the crisis in Q1 2009. This suggests limited inflation risks from higher M2 balances. Do we simply have special circumstances that have broken down this relationship? When there are more transactions being made throughout the economy, velocity increases, and the economy is likely to expand. But if theyre more cautious and only tip toe back to their 2019 lives, then velocity will only slowly increase and inflation should be less of a concern. Categories; My Account; Sources; Releases; API; Help; St. Louis Fed Home; . Velocity of M2 Money Stock . 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. While M2 velocity is currently at historical lows, inflation is clearly not high. 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). Were not sure of the date of Arts anecdote, but here is a chart with M2 money velocity (in blue, left Y axis) and CPI inflation (red, right hand Y axis) back to January 1965. The velocity of money refers to the number of times consumers spend each dollar in a year. Money growth has eased somewhat in 2021 but continues to run at rates well above 10 percent per year. The issue has to do with the velocity of money, which has never been constant, as can be seen in the figure below. The Federal Reserve might describe it as the turnover rate of a dollar through the U.S. economy. This could effectively pump the breaks on continued U.S. economic expansion and may even become a stronger headwind. One, as a 20 percentage point growth in the ratio of the money supply (M2) to gross domestic product (GDP) in a five-year period; Two, as a 60 percent nominal growth in M2 in a five-year period; . Powell or Hanke? Since the GFC, and because of record low interest rates, investors allocated monies toward various asset classes, primarily corporate stock shares and real estate. Referencing data on MV from the Federal Reserve Bank of St. Louis, you can see something noteworthy. An example of data being processed may be a unique identifier stored in a cookie. When inflation is high, prices for goods and services rise and thus the purchasing power per unit of currency decreases. All this certainly explains why the S&P keeps making new highs . Explore resources provided by the Research Division at the Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, 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. This is a change of 2.94% from last quarter and 7.36% from one year ago. Household savings rates spiked during the past couple of years, which resulted in cash hoarding in checking and savings accounts. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. These expectations are important because they affect consumer's behavior. Opinions expressed are those of the author. The former goes to new highs of 2.2x, but the latter remains contained. 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). retrieved from FRED, https://www.econlib.org/archives/2015/10/everythings_end.html. One, M2 is partially endogenous to inflation (well, really NGDP). 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." 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. Chart #2 shows the 6-mo. The money supplyis 100 for t = 0, 1. It used to be aggregate M2 was a good measure of this. Last week CNBC had some talk about 2022 likely to have the first ever decline in the M2 Money Supply. Is there such a relationship in the first place? 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. Back then, it was Chinese imports. Friedman, Milton. By clicking submit, you agree that you have read and understand ourTerms of Service,SubscriptionAgreement, andPrivacy Policy, and hereby agree to be bound by them. and (2) balances in retail Money Market Funds. 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. A nice clean relationship. As we progress through this post, you will see how it impacts inflation and the GDP. Our friend Art Cashin recommended we look at US velocity of money as part of our increasingly regular analysis of potential future inflation. One Federal Reserve Bank Plaza, So, if everyone believes it, so it must be true. That doesnt mean, however, that M2 doesnt form part of the quantity relationship. You need to read Dr. Philip George, "The Riddle of Money Finally Solved". Please, Is inflation always and everywhere a monetary phenomenon, or merely a, phenomenon? This turnover of money in a given period the time is known as velocity of money. V stands for the velocity of money (or the rate at which people spend money). 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. Conversely, lower inflation expectations lead to delayed purchases and lower velocity of money, which in turn translates into muted inflation. Related Categories . 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. That's why there is now plenty of light at the end of the inflation tunnel. The problem is that velocity of money is never constant. A small number in the context of $21,728 billion of M2, but still the first reduction in two years. Oxford University Press. The "M2 Money Supply", also referred to as "M2 Money Stock", is a measure for the amount of currency in circulation. For this reason, the charts cannot be displayed. Year-over-year M2 growth is -1.7%, and 6-mo annualized growth is -3.4%. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. 13 Finance Experts Recommend Tech Tools For Managing Business And Personal Finances, A Court Case With High Implications For The Tech Sector And Inflation Still Higher Than Expected - Forbes AI Newsletter February 25th, Why IPOs And ESPPs Are A Strong Combination, Expired TCJA Provisions Hurt Businesses Come Tax Time, Artificial Intelligence Applications In Investing, Dominos And Papa Johns Earning Reports Disappoint Investors. Inflation (CPI) in the U.S. is at a four-decade high, coming in at 8.3% year-over-year. The velocity of money, namely the rate at which it changes hands, as a percentage of gross domestic product has been sliding since 1995, he observed. So why did the monetary base increase not cause a proportionate increase in either the general price level or GDP? Chart #1 is the main attraction. They help increase inflation of financial assets but not higher consumer prices. High money velocity is usually associated with a healthy, expanding economy. Source: The Fed's response to the pandemic has greatly added to the financialization of the economy and permanently increased the demand for money. The velocity of money is a measurement of the rate at which money is exchanged in an economy. 2016. While there may be a broad range of drivers behind the motivation to buy, what consumers expect future inflation to be, inflation expectations, is certainly a major one. Beginning May 2020, M2 consists of M1 plus (1) small-denomination time deposits (time deposits in amounts of less than $100,000) less IRA and Keogh balances at depository institutions; and (2) balances in retail MMFs less IRA and Keogh balances at MMFs. During the first and second quarters of 2014, the velocity of the monetary base2 was at 4.4, its slowest pace on record. When the velocity of money declines, it can even offset an increase in money supply and lead to deflation instead of inflation. money supply * velocity = nominal GDP. Is inflation always and everywhere a monetary phenomenon, or merely a monetary policy phenomenon? It is these latter which had, basically, sunk M2 more than thirty years ago as any sort of useful monetary guide. Sign up or read more information atwww.datatrekresearch.com. Velocity of M2 Money Stock [M2V], 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. When there are more transactions being made throughout the economy, velocity increases, and the economy is likely to expand. Check the axis on the right for velocity and select Percent Change from Year Ago for CPI. 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. Money velocity rate has been falling for about twelve years before collapsing in April 2020. Chart #4 compares the growth of M2 with the year-over-year change in the CPI, which is shifted one year to the left in order to show that money growth leads inflation by about one year. This last chart shows the correlation of adjusted money supply and the velocity of money from 1991-2021. This week's stronger-than-expected February inflation data from France, Spain and Germany has led traders to price European Central Bank rates peaking near 4%, following similar moves in U.S . A Technical Approach. We and our partners use data for Personalised ads and content, ad and content measurement, audience insights and product development. If you have an ad-blocker enabled you may be blocked from proceeding. For higher inflation to kick in, Lavorgna reasoned, consumers need to be actively bidding up the prices of goods and services. 1956. Second, rate of change matters a lot. Velocity of M2 Money Stock in the US is at a current level of 1.226, up from 1.191 last quarter and up from 1.142 one year ago. Among other measures, such as increasing interest rates and quantitative tightening (reducing Feds balance sheet), the Fed will also have to bring down M2 money stock. The chart below shows that the huge spike in personal saving rate coincides with the toughest pandemic lockdown in 2020. Barnett, William A. The concept of climax is used to determine the end of market cycles. Then, why velocity of money may not mean anything for inflation after all. Then the owner of the store spends it to buy groceries. Stock - ( Eq higher inflation the GFC GDP growth may be from. 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Cashin Recommended we look at US velocity of M2 m2 money velocity and inflation Stock - Eq!