I can think of two reasons. The velocity of money is a measurement of the rate at which money is exchanged in an economy. 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. 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. Money velocity (MV) isnt a complicated concept. Historically, M2 has grown along with the economy (see in the chart below). Bitcoin Donations: bc1qvu8a9uy5p6lptdm3n3hyljer4s9ud2kfm4gv95. See why for yourself by starting a 2-week FREE trial below. You should consult with a licensed professional for advice concerning your specific situation. How this graph was created: Search FRED for "M2 Money Velocity" and choose the series "Velocity of M2 Money Stock", or M2V. Federal Reserve Bank of St. Louis Monetary Trends. Please enter your email address or username below. According to the Quantity Theory of Money, inflation depends on the money supply and its velocity. Federal Reserve Bank of St. Louis, One logical answer is the rising level Chinese imports during this period. 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. Federal Reserve Bank of St. Louis, Inflation expectations today are consistent with inflation falling to the Fed's target of 2% within the next 9-12 months, as Chart #6 shows. What is the M2 money supply? and (2) balances in retail Money Market Funds. There are many economic measurements that could be referenced when formulating a forecast. By the end of that year, M2 totaled . 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. 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. What you are seeing is a yuuge increase in the supply of money. You need to read Dr. Philip George, "The Riddle of Money Finally Solved". Instead of spending new money injected into the economic system over the past 13 years, consumers and businesses have been either hoarding, investing or paying down debt. Ratio, Quarterly, Seasonally Adjusted Q1 1959 to Q4 2022 (5 days . 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 . Is that really a big deal given 2020 record 25% growth followed by 2021 12% growth? You may opt-out by. 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. Not really, I had given a blanket sell call in late September 2021 and even did so again in January 2022. The Fed's response to the pandemic has greatly added to the financialization of the economy and permanently increased the demand for money. 2016. M2 increase of 20% to GDP followed by 5 years of 5% inflation. What is the M1 money supply? 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. retrieved from FRED, Businesses and capital allocators may find it prudent to consider diversifying into non-U.S. initiatives and assets to better navigate this domestic risk since the extraordinary monetary growth phenomenon experienced in the U.S. has been less pronounced in most other developed economies. Copyright 2023 Apple Inc. All rights reserved. A negative GDP print for Q2 2022 would mean that the U.S. is officially in a recession. 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; . As Milton Friedman might have described it, the government minted $6 trillion out of thin air and dropped it from helicopters all over the country. Please update to a modern browser: a list is available here. Charts powered by Highcharts. M2's huge growth . Chart #2 shows the 6-mo. One Federal Reserve Bank Plaza, The personal saving rate is a primary indicator to track velocity of money and inflation. Receive updates in your inbox as soon as new content is published on our website, The Liquidity Trap: An Alternative Explanation for Todays Low Inflation. Related Categories . Money velocity is a gauge of the consumers willingness to spend money. Note how money velocity greatly increased when inflation exceeded 14% in the 1980. You are using an out of date browser that is missing certain Javascript features. Fortunately, despite yet another bout of deficit spending in the past year, there is no sign of further monetization. Then, why velocity of money may not mean anything for inflation after all. Or. Wh That allows markets to feel more certain about corporate earnings leverage and growth while also enjoying the valuation benefits of lower rates. Reverse repos explain the surge in M1 relative to M2 in the lead chart. . 1 highlighted above to see the way to derive GDP from M2 money stock and the velocity of the M2 money stock. Views expressed are not necessarily those of the St. Louis Fed or Federal Reserve System. Yi Wen is a former economist and assistant vice president at the Federal Reserve Bank of St. Louis. Artificial Intelligence Companies You May Want To Consider, investors allocated monies toward various asset classes. Low money velocity is usually associated with recessions and contractions. LIVE MARKETS Will money velocity be a bigger inflation factor in 2022? R= -0.98 R^2 = 0.97. U.S. corporations are now sitting atop the highest corporate debt mountain in U.S. history. FRED Series Velocity of M2 Money Stock. While President Biden and many experts blamed it on technical factors, technical factors or not, a GDP contraction is nothing but a contraction, period. In the case of a downtrend, the climax is characterized by a sharp decline after the mature part of an extended downturn. Visit his blog: Calafia Beach Pundit (http://scottgrannis.blogspot.com/). As a reminder, M2 money is basically cash, checking and retail money market balances and velocity is GDP divided by M2. 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. Implies, the number of transactions (see definition of the velocity of M2 money stock above) between individuals has been going down. , edited by Robert Cord and Daniel Hammond. When there are more transactions being made throughout the economy, velocity increases, and the economy is likely to expand. Are you sure you want to remove this series from the graph? Please, Is inflation always and everywhere a monetary phenomenon, or merely a, phenomenon? 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. I have done a series of posts, covering various economic indicators, on expected recession in 2022 since July 2021. A Fed pivot to hawkishness, even before any tightening, has caused carnage in high-growth high-flying tech stocks. Meanwhile, Prof. Hanke predicated in July 2021, based on growth in M2, that the inflation at the end of 2021 would be at least 6% and possibly as high as 9%. 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 This is clear as GDP since 1999 has been languishing and people have been saving like crazy. CPI Inflation year-over-year Figure 3: In Contrast to the Great Depression, the Fed Prevents Substantial Deflation in the Great Recession 2007 2009 2011 2013 M2*V=P*Y. 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. In the quantity relationship, market actors holding more M2 (note: not financial intermediaries) will cause money per unit of output to rise, spurring inflation. No wholesale; no offshore. The standard formula of Monetarism predicts the former. 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 small number in the context of $21,728 billion of M2, but still the first reduction in two years. Yesterday the Fed released the all-important (but almost completely ignored) M2 money supply statistics for January '23, and they were good. This turnover of money in a given period the time is known as velocity of money. 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. Can site, link, or share provided podcast website listed and sourced. We and our partners use cookies to Store and/or access information on a device. The velocity of MZM helps determine how often financial assets are switching hands within the economy. This behavior, which also reflects a decrease in inflation, suggests that confidence in the recovery is still low. The M2 for April 2022 is lower by $81.2 billion. The information provided here is not investment, tax or financial advice. When confidence is restored, we should expect to see a rebound in the velocity of money. We can think of shorter- term transactions as consumption we might make on an everyday basis. 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. Why was there only a handful of economists who commented on it, as I noted a year ago? Manage Settings If anything, there is a slight upward slope, indicating that higher M2 velocity is associated with higher inflation, although this would not be statistically significant. When it goes up, M2 will. 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." At first this was fine, because the public was not willing or able to spend itthe demand for money was intense. Velocity of M2 Money Stock [M2V], Do I qualify? https://www.econlib.org/archives/2015/10/everythings_end.html. Second, rate of change matters a lot. Back then, it was Chinese imports. Amazon Return To Office Mandate, And Whats Happening With Amazon Stock? As human beings and social creatures . 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. M2 Money Supply Shrinking vs Inflation | Money Velocity Irrelevant?. Please review the copyright information in the series notes before sharing. One is that M2 can be a good indicator. 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. Since the GFC, and because of record low interest rates, investors allocated monies toward various asset classes, primarily corporate stock shares and real estate. Theres a couple issues with simply believing M2 = inflation. When it goes up, M2 will. Oxford University Press. Everything's Endogenous. EconLog. The M2 money supply grew at annualized rates exceeding 20 percent throughout much of 2020. 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 M2 for April 2022 is lower by $81.2 billion. 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. In other words, MZM money is M2 money minus time deposits. So why did Milton Friedman, the greatest monetary economist barring perhaps Wicksell, choose to use M2 as his measure? This gives you the first graph. Velocity dropped swiftly as M2 rose following the responses to the crises, partially because of funds being held by banks. 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. St. Louis, MO 63102, More Thats one reason why 10-year yields have stalled out a slow recovery means slower M2 velocity growth and less coincident inflation. The Fed doesn't need to do more than they already have. Learn more about the Econ Lowdown Teacher Portal and watch a tutorial on how to use our online learning resources. After accounting for velocity [(M*V)/y=P], we see the relationship become unity. Explore resources provided by the Research Division at the Federal Reserve Bank of St. Louis. 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. 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. Inflation is typically described as a persistent increase in the general price level, such as in the consumer price index. 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. Put another way, the U.S. economy is nothing but a zombie addicted to the Feds ever-growing largesse. Sumner, Scott. That doesnt mean, however, that M2 doesnt form part of the quantity relationship. 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. Case 2. This chart further suggests that the year-over-year change in the CPI will gradually fall to the Fed's 2% target over the course of this year, thanks to the huge deceleration in M2 growth over the past year. Conversely, a lower figure would mean the exact opposite, which could indicate a slowing economic backdrop. It's a psychological, self-reinforcing process. This can not be undone. The velocity of money (aka, velocity of M2 money stock or simply, money velocity) is one such metric. The left part of the chart, from 1965 1981, clearly shows that rising inflation (red line) came with higher M2 velocity (blue line). Videos showing how the St. Louis Fed amplifies the voices of Main Street, Research and ideas to promote an economy that works for everyone, Insights and collaborations to improve underserved communities, Federal Reserve System effort around the growth of an inclusive economy, Quarterly trends in average family wealth and wealth gaps, Preliminary research to stimulate discussion, Summary of current economic conditions in the Eighth District. 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. 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. This seems troubling. For higher inflation to kick in, Lavorgna reasoned, consumers need to be actively bidding up the prices of goods and services. Lucas Jr, Robert E. Two Illustrations of the Quantity Theory of Money. The American Economic Review 70, no. 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. Year-over-year M2 growth is -1.7%, and 6-mo annualized growth is -3.4%. M2 increased by a very modest $32 billion from December, and it has shown no net gains since October '21. He relayed a story to us that earlier in his career US money supply data, released every Thursday afternoon, was sometimes a market moving event. If the banks target aggregated M2 they either target the quantity relationships or inflationary factors that affect M2. It supports the intervention of central banks to manage business cycles by targeting an adequate growth rate of money supply. 1956. Forbes Finance Council is an invitation-only organization for executives in successful accounting, financial planning and wealth management firms. 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). High money velocity is usually associated with a healthy, expanding economy. We dont yet know if or how that will alter inflation trends. 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. Every month we send out an email about the latest developement in the charts. Friedman, Milton. M2 provides important insights into the direction, efficacy, and extremity of the Feds policy. The issue has to do with the velocity of money, which has never been constant, as can be seen in the figure below. If the velocity of money is increasing, then more transactions are occurring between individuals in an economy. Is this happening to you frequently? A higher MV figure means a dollar is cycling through domestic transactions for goods and services more frequently. Is that really a big deal given 2020 record 25% growth followed by 2021 12% growth? 2). Oct 25, 2020. A nice clean relationship. 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. Opinions expressed are those of the author. 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. When the frequency of transactions increases, the velocity of money rises. Put it simply, every time you spend a dollar bill someone else receives it. Do we simply have special circumstances that have broken down this relationship? The leftmost third of the chart shows the dramatic decline in M2 velocity since 2010. 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. Why, then, has inflation remained persistently low (below 2 percent) during this period? 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. How could that not have resulted in higher prices? Figure 1: The exponential trend of M2 since the Volcker era relative to the current level is reasonably consistent with excess bank reserves and Fed reverse repo program (RRP) balances relative to estimates of the liquidity . So, if everyone believes it, so it must be true. The total stock of M2 jumped from 70% of GDP to 90% and is now back to 84%. This site requires JavaScript to run correctly. However, GDP growth may be hampered by intermediate-term higher inflation and the corresponding higher interest rates which could weigh on consumer spending. 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