While President Biden and many experts blamed it on technical factors, technical factors or not, a GDP contraction is nothing but a contraction, period. I can think of two reasons. A key indicator to track velocity of money is the personal saving rate. M2 is a measure of the money supply that includes cash, checking deposits, and easily convertible near money. Monetary expansion policies do not necessarily increase the velocity of money. That is what happened in the 1990s. Retirement account balances and time deposits above $100,000 are omitted from M2. It spiked in March 2020 and has remained at high levels since then. Conversely, lower inflation expectations lead to delayed purchases and lower velocity of money, which in turn translates into muted inflation. 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. 2). The concept of climax is used to determine the end of market cycles. Youre probably familiar with economic data like unemployment figures, Fed funds rate and the inflation rate. 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. M2*V=P*Y. Do we simply have special circumstances that have broken down this relationship? and (2) balances in retail Money Market Funds. Is that really a big deal given 2020 record 25% growth followed by 2021 12% growth? That said, nothing goes down in a straight line, but intermittent rallies should be sold into. The second is that Friedman preferred the divisia of M2. When it goes up, M2 will. Source: U.S. corporations are now sitting atop the highest corporate debt mountain in U.S. history. 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. Friedman, Milton. Second, rate of change matters a lot. Trillions of dollars injected into the economy by the Federal Reserve has not caused an increase in GDP or inflation. Releases from Federal Reserve Bank of St. Louis, More Scott Grannis was Chief Economist from 1989 to 2007 at Western Asset Management Company, a Pasadena-based manager of fixed-income funds for institutional investors around the globe. M2 Money Supply Shrinking vs Inflation | Money Velocity Irrelevant?. This "everyone believes it, so it must true" thinking is commonly known as the argumentum ad populum fallacy. I dont see a bottom yet. This is a moderately strong relationship. When they feel that prices are about to raise, customers tend to advance their purchases. Is inflation always and everywhere a monetary phenomenon, or merely a monetary policy phenomenon? 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. What you are seeing is a yuuge increase in the supply of money. Federal Reserve Bank of St. Louis; In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. 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. 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. 1). Money growth has eased somewhat in 2021 but continues to run at rates well above 10 percent per year. A declining M2 constitutes deflation. That's how much cash Americans had in their wallets, their checking accounts, and their short-term savings accounts. 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. The Fed doesn't need to do more than they already have. 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. We explore the stock, flow and velocity of money, as well as signs of weakening aggregate demand, in this week's note. There is a better alternative than line graphs to eyeball correlations, though: scatter plots. Copyright Broken Pie Chart Podcast. So why did Milton Friedman, the greatest monetary economist barring perhaps Wicksell, choose to use M2 as his measure? Copyright 2023 Apple Inc. All rights reserved. However, that will depend on GDP remaining at least at its current level. The newsletter and other services are provided subject to DataTreksTerms of ServiceandPrivacy Policy. All rights reserved. Such an unprecedented increase in money demand has slowed down the velocity of money, as the figure below shows. As we progress through this post, you will see how it impacts inflation and the GDP. Two, velocity plays a large factor in the relationship: . Are you sure you want to remove this series from the graph? M2 Velocity is a . If you have an ad-blocker enabled you may be blocked from proceeding. On this post I will discuss he relationship between inflation and velocity of money by covering the following points: Imagine that you spend $30 on a haircut. Then, why velocity of money may not mean anything for inflation after all. One is that M2 can be a good indicator. Household savings rates spiked during the past couple of years, which resulted in cash hoarding in checking and savings accounts. Velocity of M2 Money Stock [M2V], Friedman and Divisia Monetary Measures. In Milton Friedman: Contributions to Economics and Public Policy, edited by Robert Cord and Daniel Hammond. 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. https://www.econlib.org/archives/2015/10/everythings_end.html. While M2 velocity is currently at historical lows, inflation is clearly not high. Further, it is lower than any time since 1960. An error appeared while loading the data. Federal Reserve Bank of St. Louis, And inflation was lower in the 2010s than any prior period, but that feels more like correlation with declining money supply than direct causation. Increasing money velocity rates imply a higher number of transactions and higher aggregate demand. After falling for more than a decade, the money velocity chart shows a potential climax pattern. Conversely, a lower figure would mean the exact opposite, which could indicate a slowing economic backdrop. The charts below illustrate this point. This can not be undone. Maria Arias is a FRED Data Engineer at the St. Louis Fed. So far, so good. He was a member of Western's Investment Strategy Committee, was responsible for developing the firm's domestic and international outlook, and provided consultation and advice on investment and asset allocation strategies to CFOs, Treasurers, and pension fund managers. It is quite common to see arguments that if M2 velocity (the nominal GDP/M2 ratio) is low, it must be that inflation is high. For this reason, the charts cannot be displayed. Some of our partners may process your data as a part of their legitimate business interest without asking for consent. 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. 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. Most surprising of all: how in the world could the Fed not see it? The Federal Reserve might describe it as the turnover rate of a dollar through the U.S. economy. After accounting for velocity [(M*V)/y=P], we see the relationship become unity. , edited by Robert Cord and Daniel Hammond. A higher MV figure means a dollar is cycling through domestic transactions for goods and services more frequently. Market Implications 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. Is velocity and inflation correlated? 1956. Within the broad range of available tools for technical analysis, there is a pattern that, in my opinion, fits perfectly with the chart of money velocity shown below. According to the Quantity Theory of Money, inflation depends on the money supply and its velocity. M2 velocity and inflation Posted on August 21, 2014 It is quite common to see arguments that if M2 velocity (the nominal GDP/M2 ratio) is low, it must be that inflation is high. Report. 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). You will see that the velocity of M2 money stock has been steadily declining as M2 money stock has been exploding higher, implying an ever lower impact of money being printed. For more information on the H.6 release changes and the regulatory amendment that led to the creation of the other liquid deposits component and its inclusion in the M1 monetary aggregate, see the H.6 announcements and Technical Q&As posted on December 17, 2020. To view the purposes they believe they have legitimate interest for, or to object to this data processing use the vendor list link below. I have an alternative to all the "deflation" vs "inflation" debates - an environment that will be stable with just modest inflation . This implies that the unprecedented monetary base increase driven by the Feds large money injections through its large-scale asset purchase programs has failed to cause at least a one-for-one proportional increase in nominal GDP. 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 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. Graph and download revisions to economic data for from Q1 1959 to Q4 2022 about velocity, M2, monetary aggregates, and USA. 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. So why did the monetary base increase not cause a proportionate increase in either the general price level or GDP? Please, Is inflation always and everywhere a monetary phenomenon, or merely a, phenomenon? The problem is that velocity of money is never constant. View more of Maria's work. St. Louis, MO 63102, More . Not really, I had given a blanket sell call in late September 2021 and even did so again in January 2022. Lucas Jr, Robert E. Two Illustrations of the Quantity Theory of Money. The American Economic Review 70, no. Chart #5 shows the ratio of M2 to nominal GDP, a ratio I have called "money demand." This blog offers commentary, analysis and data from our economists and experts. One Federal Reserve Bank Plaza, When confidence is restored, we should expect to see a rebound in the velocity of money. Money velocity is a gauge of the consumers willingness to spend money. It used to be aggregate M2 was a good measure of this. The M2 for April 2022 is lower by $81.2 billion. Monetary economist barring perhaps Wicksell, choose to use M2 as his measure the can. 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