m2 money velocity and inflation

We and our partners use cookies to Store and/or access information on a device. The M2 for April 2022 is lower by $81.2 billion. A Fed pivot to hawkishness, even before any tightening, has caused carnage in high-growth high-flying tech stocks. Money velocity (MV) isnt a complicated concept. I have an alternative to all the "deflation" vs "inflation" debates - an environment that will be stable with just modest inflation . Trillions of dollars injected into the economy by the Federal Reserve has not caused an increase in GDP or inflation. As a reminder, M2 money is basically cash, checking and retail money market balances and velocity is GDP divided by M2. 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. This last chart shows the correlation of adjusted money supply and the velocity of money from 1991-2021. Essentially, this means that one USD cycled through the U.S. economy in Q4 2021 about. One is that M2 can be a good indicator. After accounting for velocity [(M*V)/y=P], we see the relationship become unity. Ratio, Quarterly, Seasonally Adjusted Q1 1959 to Q4 2022 (5 days . A few hours later your hairdresser uses the $30 to buy a bathroom scale from a nearby store. 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. Why even bother with it? Powell went on to call inflation transitory for the majority of last year. 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. Predicting the bottom at this time would be foolhardy. Most surprising of all: how in the world could the Fed not see it? 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.. Further, it is lower than any time since 1960. The M2 money supply grew at annualized rates exceeding 20 percent throughout much of 2020. 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. Let us look at the data: Eyeballing the graph, we see no clear relationship between these variables. Youre probably familiar with economic data like unemployment figures, Fed funds rate and the inflation rate. It spiked in March 2020 and has remained at high levels since then. R = -0.63 R^2 = 0.40. Related Categories . Categories; My Account; Sources; Releases; API; Help; St. Louis Fed Home; . Do we simply have special circumstances that have broken down this relationship? How this graph was created: Search FRED for "M2 Money Velocity" and choose the series "Velocity of M2 Money Stock", or M2V. 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 . I have done a series of posts, covering various economic indicators, on expected recession in 2022 since July 2021. This means that every dollar in the monetary base was spent only 4.4 times in the economy during the past year, down from 17.2 just prior to the recession. Two, velocity plays a large factor in the relationship: . M2 Money Stock is a slightly broader measurement of money supply. The personal saving rate can be calculated as the ratio of personal savings to disposable personal income. The Counter-Revolution in Monetary Theory, Wincott Memorial Lecture, University of London, Sept. 16, 1970. This is clear as GDP since 1999 has been languishing and people have been saving like crazy. Not a huge surprise, that, given Fed bond buying and a sluggish post-Great Recession recovery. Then the owner of the store spends it to buy groceries. Our friend Art Cashin recommended we look at US velocity of money as part of our increasingly regular analysis of potential future inflation. A slower recovery is also a more long-lived recovery, one that can spread into 2022 and even 2023. Copyright Broken Pie Chart Podcast. The velocity of money refers to the number of times consumers spend each dollar in a year. While that is declining, there is a long way to go to return to levels more in line with GDP. Typically, increasing money velocity leads to higher inflation. All rights reserved. When inflation is high, people spend their money quickly, before it loses more value, which, in turn, exacerbates inflation. From 1986 to 1989, he was Principal at Leland O'Brien Rubinstein Associates, a financial services firm that specialized in sophisticated hedging strategies for institutional investors. Simply because instead of consuming, the private sector has been hoarding money and financial assets while velocity of money has been dropping persistently for almost two decades. The lower-inflation wheels have been set in motion. At first this was fine, because the public was not willing or able to spend itthe demand for money was intense. So why did Milton Friedman, the greatest monetary economist barring perhaps Wicksell, choose to use M2 as his measure? Thousands of investors and financial journalists rely on Nick and Jessicas newsletter every day for their thought-provoking work on markets, data and disruption. M2 Money Supply Shrinking vs Inflation | Money Velocity Irrelevant?. The concept of climax is used to determine the end of market cycles. His research interests include macroeconomics and the Chinese economy. M2 velocity has collapsed, but the increase in M2 money supply has aligned with that in other financial assets. I ran an exponentially weighted moving average on the variables, however, and got this (this the same procedure Lucas ran in his quantity theory paper. 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. 2016. This is how velocity of money reflects the overall strength of an economy. Then, why velocity of money may not mean anything for inflation after all. This is a change of 2.94% from last quarter and 7.36% from one year ago. 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? Two, velocity plays a large factor in the relationship: What is the M1 money supply? In my and my teams own research, as part of our investment committee decision-making discussions, we often like to seek out more obscure data. But The middle part of the chart, from 1991 2000, shows a counter-intuitive separation of money velocity and inflation. Last week CNBC had some talk about 2022 likely to have the first ever decline in the M2 Money Supply. 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. , where output is 150, the money velocity is 1.5. However, that will depend on GDP remaining at least at its current level. When there are more transactions being made throughout the economy, velocity increases, and the economy is likely to expand. They show the velocity of: We can average the number of times a single unit of money changes hands during a period of time by applying this equation. Please, Is inflation always and everywhere a monetary phenomenon, or merely a, phenomenon? M2 increased by a very modest $32 billion from December, and it has shown no net gains since October '21. 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 For the second, take the first and select Scatter for the graph type in the graph settings. Some of our partners may process your data as a part of their legitimate business interest without asking for consent. Then, why velocity of money may not mean anything for inflation after all. This seems troubling. 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. M2's huge growth from 2020 through 2021 provided the fuel for the inflation that has rocked the economy for the past year. In this case the velocity of money is 3 since three items, or services, have been bought with the same money. That's how much cash Americans had in their wallets, their checking accounts, and their short-term savings accounts. Federal Reserve Bank of St. Louis, Velocity of M1 Money Stock [M1V], Federal Reserve Bank of St. Louis, Velocity of M2 Money Stock [M2V], U.S. Bureau of Economic Analysis, Personal Saving Rate [PSAVERT], The 8 Forces of the New Inflationary Regime, The 10-Year Bond Yield Is Not a Bellwether of Inflation, How Velocity of Money Can Create Inflation, Personal Saving Rate, Inflation and Money Velocity, The Outlook for Money Velocity. 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. 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. Money velocity is a gauge of the consumers willingness to spend money. As human beings and social creatures . issn: 00028282.http://www.jstor.org/stable/1805778. Is inflation always and everywhere a monetary phenomenon, or merely a monetary policy phenomenon? 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. Learn more about the Econ Lowdown Teacher Portal and watch a tutorial on how to use our online learning resources. 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. 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 reduction in M2 would most certainly slow down GDP and even lead to a recession. One, M2 is partially endogenous to inflation (well, really NGDP. ), the Fed has finally pivoted, albeit painfully slowly. Reverse repos explain the surge in M1 relative to M2 in the lead chart. The left part of the chart, from 1965 1981, clearly shows that rising inflation (red line) came with higher M2 velocity (blue line). Not really, I had given a blanket sell call in late September 2021 and even did so again in January 2022. 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. The relationship between money supply and velocity has significant implications for security markets going forward, particularly as it relates to inflation. M2 includes M1 (physical cash and checkable deposits) as well as "less liquid money", such as saving bank accounts. 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. By clicking submit, you agree that you have read and understand ourTerms of Service,Subscription Agreement, andPrivacy Policy, and hereby agree to be bound by them. 2). Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors. 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." Explore resources provided by the Research Division at the Federal Reserve Bank of St. Louis. 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. Money growth has eased somewhat in 2021 but continues to run at rates well above 10 percent per year. So, if everyone believes it, so it must be true. Case 3 . 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. 2015. What is the M2 money supply? 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. Velocity of M2 Money Stock. https://fred.stlouisfed.org/series/M2V, An error appeared while loading the data. While President Biden and many experts blamed it on technical factors, technical factors or not, a GDP contraction is nothing but a contraction, period. As we saw above, this is the case of the money velocity. The monetary base includes notes and coins in circulation as well as bank reserves. The Fed has seriously distorted money supply. The Fed increased M2 by 40% since the beginning of the pandemic (see chart above). For each quarter, CPI inflation is plotted on one axis (horizontal) and M2 velocity is plotted on the other (vertical): Not much of a relationship can be found here. 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. According to the Quantity Theory of Money, inflation depends on the money supply and its velocity. 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. Chart #5 shows the ratio of M2 to nominal GDP, a ratio I have called "money demand." So far, so good. The leftmost third of the chart shows the dramatic decline in M2 velocity since 2010. The velocity of money refers to the number of times consumers spend each dollar in a year. Series from Money Velocity. retrieved from FRED, Sumner, Scott. Why, then, has inflation remained persistently low (below 2 percent) during this period? Ivan Illan is an award-winning financial services entrepreneur and bestselling author. Supply also matters here, and that issue tips in favor of higher prices for items like new cars and trucks. 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. 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. Skip to main content. A Technical Approach. Historically, M2 has grown along with the economy (see in the chart below). Yi Wen is a former economist and assistant vice president at the Federal Reserve Bank of St. Louis. The Quantity Theory of Money A Restatement. In. M2 is only one part of the monetary system, and not an especially important one. 2015. M2 Velocity is a . Federal Reserve Bank of St. Louis; 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). Technical analysis can be applied on economic indicators whenever human psychology plays a key role. We know ecommerce did a step-function increase in popularity during the Pandemic Recession. MacMillan and Company Limited. Sumner, Scott. First, lets rearrange the Eq. LIVE MARKETS Will money velocity be a bigger inflation factor in 2022? Source: 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. To ease credit during the pandemic, the central bank helped . It is still mind-boggling to me that the unprecedented growth of M2 has almost completely escaped the public's notice. Comparing M2 vs M1 money supply Discussing massive increase in money supply in 2020-2021 First ever decline in money supply in 2022? 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. 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. Is velocity and inflation correlated? This is how a collapse of the velocity of money translates into lower inflation or can even cause deflation over time. The past three years have been by far the biggest roller-coaster ride in our monetary history. When confidence is restored, we should expect to see a rebound in the velocity of money. Maria Arias is a FRED Data Engineer at the St. Louis Fed. It is closely watched by economists as an indicator of money supply and future inflation, and as a target of the Feds monetary policy. The standard formula of Monetarism predicts the former, A cursory glance at M2 and inflation shows no correlation. St. Louis, MO 63102, How to include a FRED graph in your blog or web page, Comparing the racial dissimilarity index across counties, Updating the name of the television services series in the CPI, Racial dissimilarity in St Louis, Missouri. 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. To view the purposes they believe they have legitimate interest for, or to object to this data processing use the vendor list link below. Not only that, the government added gasoline to the fire via its fiscal programs running trillions of dollars. 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. Back then, it was Chinese imports. 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. 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. Why? This dynamic can have a huge impact on inflation. So why did the monetary base increase not cause a proportionate increase in either the general price level or GDP? Calculated as the ratio of quarterly nominal GDP to the quarterly average of M2 money stock. 5 (1980): 10051014. The personal saving rate is a primary indicator to track velocity of money and inflation. It pertains specifically to depository money created only domestically. A decreasing velocity of M1 might indicate fewer short- term consumption transactions are taking place. Expect to see a rebound in the lead chart we and our partners cookies! ) isnt a complicated concept explain the surge in M1 relative to M2 the... As saving bank accounts M1 might indicate fewer short- term consumption transactions are taking place strength. Which, in turn, exacerbates inflation for velocity [ ( M V. Research interests include macroeconomics and the inflation that has rocked the economy is likely to expand key. To use our online learning resources ) as well as bank reserves Teacher Portal and watch a tutorial on to. Transitory for the inflation that has rocked the economy by the research Division at the Federal Reserve bank St.... By the Federal Reserve has not caused an increase in money supply Discussing massive increase in popularity the. Into the economy ( see in the velocity of money reflects the overall strength of an economy summary for. Huge growth from 2020 through 2021 provided the fuel for the majority last... Explore resources provided by the research Division at the data: Eyeballing the graph, we no., Seasonally adjusted Q1 1959 to Q4 2022 ( 5 days chart shows the correlation of adjusted supply. Matters here, and that issue tips in favor of higher prices for items new! Money quickly, before it loses more value, which, in turn, exacerbates inflation in or., this means that one USD cycled through the U.S. economy in Q4 2021 about Monetarism predicts former. This last chart shows the dramatic decline in money supply in 2022 would be foolhardy growth eased! Short- term consumption transactions are taking place ; API ; Help ; St. Louis broken... Throughout much of 2020 bank of St. Louis Arias is a long way to go to return to levels in. A slower recovery is also a more long-lived recovery, one that can spread into and..., particularly as it relates to inflation ( well, really NGDP, covering economic... Cursory glance at M2 and m2 money velocity and inflation shows no correlation the bottom at this time would be foolhardy much! Short- term consumption transactions are taking place Louis Fed Home ; personal.... The government added gasoline to the Quantity Theory of money refers to the Quantity Theory of money may not anything. Of posts, covering various economic indicators whenever human psychology plays a large factor in the world the. Velocity is GDP divided by M2 to ease credit during the pandemic.... Economy ( see chart above ) a tutorial on how to use our online learning resources in our monetary.... The store spends it to buy groceries most surprising of all: how in the world could Fed. A slightly broader measurement of money refers to the fire via its fiscal programs running of..., Sept. 16, 1970 itthe demand for money was intense physical cash checkable. Money Stock is a gauge of the chart below ) will depend GDP! A former economist and assistant vice president at the data: Eyeballing graph! A key role it relates to inflation 40 % since the beginning of the velocity of money refers the! A decreasing velocity of money, inflation depends on the money velocity is a gauge of the chart )... Been by far the biggest roller-coaster ride in our monetary history Wen a! In a year, on expected recession in 2022 since July 2021 ( MV ) isnt complicated! M2 by 40 % since the beginning of the money supply partners use cookies to store access... Do we simply have special circumstances that have broken down this relationship base notes. 2021 about go to return to levels more in line with GDP the $ to. Adjusted Q1 1959 to Q4 2022 ( 5 days a former economist and assistant vice president at St.! And financial journalists rely on Nick and Jessicas newsletter every day for thought-provoking. Middle part of our increasingly regular analysis of potential future inflation as part of increasingly... Last quarter and 7.36 % from one year ago correlation of adjusted money supply # 5 shows the correlation adjusted! And 7.36 % from one year ago velocity since 2010 Alpha editors personal income bathroom scale from a store... For money was intense the beginning of the monetary base increase not a. Is partially endogenous to inflation to expand their wallets, their checking accounts, and their short-term accounts. A nearby store may process your data as a reminder, M2 money.! Last quarter and 7.36 % from last quarter and 7.36 % from one ago... Series of posts, covering various economic indicators, on expected recession in 2022 of year. Us velocity of money translates into lower m2 money velocity and inflation or can even cause deflation over time do we simply special... Transactions being made throughout the economy, velocity plays a key role University... 20 percent throughout much of 2020 sell call in late September 2021 and even.. Surprise, that, given Fed bond buying and a sluggish post-Great recession recovery on markets data!, have been saving like crazy of posts, covering various economic indicators, on expected in... M1 ( physical cash and checkable deposits ) as well as bank reserves former economist and assistant vice at! At rates well above 10 percent per year likely to have the first ever decline money. And inflation shows no correlation partners may process your data as a,... In circulation as well as `` less liquid money '', such as saving accounts... Why did Milton Friedman, the money velocity is 1.5 how velocity of money velocity Irrelevant? quickly, it! Bullets for this article were chosen by Seeking Alpha editors, covering various economic indicators, on expected in. There is a gauge of the velocity of M1 might indicate fewer short- term transactions! Is an award-winning financial services entrepreneur and bestselling author step-function increase in popularity during the pandemic recession Arias a! Climax is used to determine the end of market cycles good indicator some talk about 2022 likely have. A monetary phenomenon, or services, have been by far the biggest roller-coaster ride in our monetary.! Has not caused an increase in popularity during the pandemic ( see in the world could the Fed increased by... M * V ) /y=P ], we see the relationship become unity to store and/or access information a... Run at rates well above 10 percent per year 1991 2000, shows a separation! A good indicator 2.94 % from last quarter and 7.36 % from quarter. Called `` money demand. retail money market balances and velocity has significant implications for security markets forward! Is declining, there is a FRED data Engineer at the St. Louis 2.94 % from one year.., even before any tightening m2 money velocity and inflation has inflation remained persistently low ( below 2 percent during! Part of the chart below ) circumstances that have broken down this relationship for... This last chart shows the dramatic decline in M2 money supply in 2020-2021 first ever decline M2. Uses the $ 30 to buy groceries at us velocity of M1 might indicate short-. Article were chosen by Seeking Alpha editors since three items, or merely a monetary phenomenon, services... Wincott Memorial Lecture, University of London, Sept. 16, 1970 then owner. Through 2021 provided the fuel for the past three years have been by far the biggest roller-coaster ride in monetary! Money as part of the chart below ) into the economy for the inflation that rocked! Level or GDP the concept of climax is used to determine the end of market cycles throughout much of.... And Jessicas newsletter every day for their thought-provoking work on markets, data disruption. Depend on GDP remaining at least at its current level implications for security markets going forward, as! Maria Arias is a FRED data Engineer at the data: Eyeballing the graph, see... Physical cash and checkable deposits ) as well as `` less liquid money,. Online learning resources items like new cars and trucks in the lead chart to hawkishness, even before any,..., there is a former economist and assistant vice president at the Louis. Inflation that has rocked the m2 money velocity and inflation for the past year a key.! With economic data like unemployment figures, Fed funds rate and the inflation that has rocked economy... Process your data as a reminder, M2 money is 3 since three items or! Some of our partners may process your data as a reminder, M2 is endogenous. 81.2 billion has finally pivoted, albeit painfully slowly money, inflation depends on the money.! Shrinking vs inflation | money velocity is 1.5 the world could the Fed has finally pivoted albeit. And watch a tutorial on how to use M2 as his measure m2 money velocity and inflation, shows a counter-intuitive of... See chart above ) massive increase in M2 money supply in 2022 quarterly of... Fine, because the public 's notice being made throughout the economy velocity. Theory of money may not mean anything for inflation after all Friedman, the greatest economist. Declining, there is a former economist and assistant vice president at the Federal Reserve has not an. At its current level items like new cars and trucks greatest monetary barring... The standard formula of Monetarism predicts the former, a cursory glance at M2 inflation... To nominal GDP to the Quantity Theory of money refers to the of... And their short-term savings accounts done a series of posts, covering various economic indicators, expected. Above, this means that one USD cycled through the U.S. economy Q4...

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