In this case the velocity of money is 3 since three items, or services, have been bought with the same money. When the velocity of money declines, it can even offset an increase in money supply and lead to deflation instead of inflation. and in the process is giving huge amounts of free money to financial institutions. Friedman, Milton. 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%. 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. That's why there is now plenty of light at the end of the inflation tunnel. That allows markets to feel more certain about corporate earnings leverage and growth while also enjoying the valuation benefits of lower rates. It used to be aggregate M2 was a good measure of this. Amazon Return To Office Mandate, And Whats Happening With Amazon Stock? 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. 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. When inflation is high, people spend their money quickly, before it loses more value, which, in turn, exacerbates inflation. The first signs of this are now on record. These expectations are important because they affect consumer's behavior. 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. 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. M2's huge growth from 2020 through 2021 provided the fuel for the inflation that has rocked the economy for the past year. 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. Chart #1 is the main attraction. 5 (1980): 10051014. A few hours later your hairdresser uses the $30 to buy a bathroom scale from a nearby store. FRED Series Velocity of M2 Money Stock. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. How this graph was created: Search FRED for "M2 Money Velocity" and choose the series "Velocity of M2 Money Stock", or M2V. A small number in the context of $21,728 billion of M2, but still the first reduction in two years. Not a huge surprise, that, given Fed bond buying and a sluggish post-Great Recession recovery. This is how velocity of money reflects the overall strength of an economy. Oct 25, 2020. Why was there only a handful of economists who commented on it, as I noted a year ago? Velocity is a ratio of nominal GDP to a measure of the money supply (M1 or M2). 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 . One of the ways the Fed achieves its goals is by manipulating M2 money stock. In the U.S., the Feds dual mandate is to balance unemployment and inflation. Friedman and Divisia Monetary Measures. In Milton Friedman: Contributions to Economics and Public Policy, edited by Robert Cord and Daniel Hammond. The growth of M2, by over $6 trillion in two years, was the result of the monetization of roughly $6 trillion of Treasury debt issued to fund a tsunami of federal transfer payments in that same period. 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. That doesnt mean, however, that M2 doesnt form part of the quantity relationship. . The monetary base includes notes and coins in circulation as well as bank reserves. There's a couple issues with simply believing M2 = inflation. Two, velocity plays a large factor in the relationship: . Do we simply have special circumstances that have broken down this relationship? 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. Opinions expressed are those of the author. Increasing money velocity rates imply a higher number of transactions and higher aggregate demand. It is all hindsight. Quarterly. Strange as it may sound, we think the market has settled on the idea that American consumers will only slowly return to old habits. Expertise from Forbes Councils members, operated under license. M2 provides important insights into the direction, efficacy, and extremity of the Feds policy. Referencing data on MV from the Federal Reserve Bank of St. Louis, you can see something noteworthy. According to Bannister and Forward (2002, page 28), Money supply growth and inflation are inexorably linked. The Counter-Revolution in Monetary Theory, Wincott Memorial Lecture, University of London, Sept. 16, 1970. 2). 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. Last week CNBC had some talk about 2022 likely to have the first ever decline in the M2 Money Supply. So, if everyone believes it, so it must be true. M2 velocity has collapsed, but the increase in M2 money supply has aligned with that in other financial assets. Please enter your email address or username below. 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. 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. Over time, this dynamic translates into higher velocity of money and higher inflation due to rising aggregate demand. 1). M2 increased by a very modest $32 billion from December, and it has shown no net gains since October '21. The standard formula of Monetarism predicts the former. This can not be undone. In the quantity relationship, market actors holding more M2 (note: not financial intermediaries) will cause money per unit of output to rise, spurring inflation. For higher inflation to kick in, Lavorgna reasoned, consumers need to be actively bidding up the prices of goods and services. We can think of shorter- term transactions as consumption we might make on an everyday basis. Please let me know if this happens regularly @silvan_frank. R= -0.98 R^2 = 0.97. One, M2 is partially endogenous to inflation (well, really NGDP). Is there such a relationship in the first place? Velocity of M2 Money Stock. It spiked in March 2020 and has remained at high levels since then. 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. 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 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. 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). Is this happening to you frequently? When the velocity of money declines, it can even offset an increase in money supply and lead to deflation instead of inflation. This suggests limited inflation risks from higher M2 balances. Velocity dropped swiftly as M2 rose following the responses to the crises, partially because of funds being held by banks. Money demand spiked in the initial stages of the Covid panic, and this neutralized the inflation potential of monetized debt. So why did Milton Friedman, the greatest monetary economist barring perhaps Wicksell, choose to use M2 as his measure? 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? This dynamic can have a significant effect on inflation indexes. Note how money velocity greatly increased when inflation exceeded 14% in the 1980. All this certainly explains why the S&P keeps making new highs . This would shock the markets even more than what the market has gone through since October 2021. issn: 00028282. While that is declining, there is a long way to go to return to levels more in line with GDP. 2016. 1 highlighted above to see the way to derive GDP from M2 money stock and the velocity of the M2 money stock. Federal Reserve Bank of St. Louis, Calculated as the ratio of quarterly nominal GDP to the quarterly average of M2 money stock. Is inflation always and everywhere a monetary phenomenon, or merely a monetary policy phenomenon? Maria Arias is a FRED Data Engineer at the St. Louis Fed. It is these latter which had, basically, sunk M2 more than thirty years ago as any sort of useful monetary guide. This is a BETA experience. 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 . Please. 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. If the velocity of money is increasing, then more transactions are occurring between individuals in an economy. Thus, it is precisely the sharp decline in velocity that has offset the sharp increase in money supply, leading to the almost no change in nominal GDP (either P or Q). That is the mere weight of the crowd of people on its own can be more powerful than the actual merits of something. The Quantity Theory of Money A Restatement. In The Optimum Quantity of Money and Other Essays, published 1969. First, lets rearrange the Eq. Related Categories . The second is that Friedman preferred the divisia of M2. 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. Historically, M2 has grown along with the economy (see in the chart below). Are labor supply and labor demand out of balance? . For this reason, the charts cannot be displayed. Explore resources provided by the Research Division at the Federal Reserve Bank of St. Louis. This gives you the first graph. Artificial Intelligence Companies You May Want To Consider, investors allocated monies toward various asset classes. m2 '' ^^ m2 . While M2 velocity is currently at historical lows, inflation is clearly not high. 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. 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. Case 3 . After falling for more than a decade, the money velocity chart shows a potential climax pattern. When there are more transactions being made throughout the economy, velocity increases, and the economy is likely to expand. Reverse repos explain the surge in M1 relative to M2 in the lead chart. After accounting for velocity [(M*V)/y=P], we see the relationship become unity. What is the M2 money supply? 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). To view the purposes they believe they have legitimate interest for, or to object to this data processing use the vendor list link below. Indeed, during the prerecession period, for every 1 percentage point decrease in 10-year Treasury note interest rates, the velocity of the monetary base decreased 0.17 points, based on a linear regression model of the velocity onto interest rates. Please be sure to comment, debate and let me know where you think the dollar goes next. This turnover of money in a given period the time is known as velocity of money. M2 increased by a very modest $32 billion from December, and it has shown no net gains since October '21. Implies, the number of transactions (see definition of the velocity of M2 money stock above) between individuals has been going down. Household savings rates spiked during the past couple of years, which resulted in cash hoarding in checking and savings accounts. As we saw above, this is the case of the money velocity. M2 Velocity. Impact on GDP and Investors As we have seen above, the U.S. GDP growth is heavily contingent upon the money printing largesse of the Fed. It's a psychological, self-reinforcing process. At first this was fine, because the public was not willing or able to spend itthe demand for money was intense. However, that will depend on GDP remaining at least at its current level. Explore resources provided by the Research Division at the Federal Reserve Bank of St. Louis. One is that M2 can be a good indicator. Low money velocity is usually associated with recessions and contractions. 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. Is that really a big deal given 2020 record 25% growth followed by 2021 12% growth? 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. Not only that, the government added gasoline to the fire via its fiscal programs running trillions of dollars. Skip to main content. The Quantity Theory of Money A Restatement. In. Therefore, a huge increase in the denominator naturally results in a lower figure without the same corresponding increase in GDP. Now, it could be the deflationary impact of consumer activities like online shopping since this offers greater price transparency than single store in-person visits. Friedman and Divisia Monetary Measures. In. 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. 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. 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. The chart above plots the yearly M2 Growth Rate and the Inflation Rate, which is defined as the yearly change in the Consumer Price Index (CPI). 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." A nice clean relationship. Afterall, the formula for MV is simple: GDP/money supply. Check the axis on the right for velocity and select Percent Change from Year Ago for CPI. Everything's Endogenous., Barnett, William A. When it goes up, M2 will. Yesterday the Fed released the all-important (but almost completely ignored) M2 money supply statistics for January '23, and they were good. Graph and download revisions to economic data for from Q1 1959 to Q4 2022 about velocity, M2, monetary aggregates, and USA. 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. We're about halfway back, on the money demand scale, to where we were pre-Covid. m2 6 r^2 = 0.0259. Historical Statistics of the United States, Colonial Times to 1970, M2 Money Stock until 1959, Chapter X, pages 992-993. Q stands for the quantity of goods and services produced. 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 . 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 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. Sign up or read more information atwww.datatrekresearch.com. Do we simply have special circumstances that have broken down this relationship? Powell went on to call inflation transitory for the majority of last year. It is closely watched by economists as an indicator of money supply and future inflation, and as a target of the Feds monetary policy. 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. 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. Can site, link, or share provided podcast website listed and sourced. Explore resources provided by the Research Division at the Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, In the case of a downtrend, the climax is characterized by a sharp decline after the mature part of an extended downturn. Money, no matter how much may be in the system, doesnt translate into inflation if it just sits in the bank collecting dust. Since the GFC, and because of record low interest rates, investors allocated monies toward various asset classes, primarily corporate stock shares and real estate. The M2 for April 2022 is lower by $81.2 billion. The newsletter and other services are provided subject to DataTreksTerms of ServiceandPrivacy Policy. 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. Comparing M2 vs M1 money supply Discussing massive increase in money supply in 2020-2021 First ever decline in money supply in 2022? As we have seen above, the U.S. GDP growth is heavily contingent upon the money printing largesse of the Fed. 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. His research interests include macroeconomics and the Chinese economy. A Fed pivot to hawkishness, even before any tightening, has caused carnage in high-growth high-flying tech stocks. Do I qualify? We see 3 things going on here: 2016. 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). The M2 money supply exploded from $15.5 trillion in February '20 to $21.5 trillion in January '22. Why even bother with it? 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. 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. Thousands of investors and financial journalists rely on Nick and Jessicas newsletter every day for their thought-provoking work on markets, data and disruption. According to the Quantity Theory of Money, inflation depends on the money supply and its velocity. In other words, MZM money is M2 money minus time deposits. However, GDP growth may be hampered by intermediate-term higher inflation and the corresponding higher interest rates which could weigh on consumer spending. In any event, here we are; the flood of funny money is receding. My R^2 was 0.754. The charts below illustrate this point. Please update to a modern browser: a list is available here. Yi Wen is a former economist and assistant vice president at the Federal Reserve Bank of St. Louis. Case 2. 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. When there are more transactions being made throughout the economy, velocity increases, and the economy is likely to expand. It is still mind-boggling to me that the unprecedented growth of M2 has almost completely escaped the public's notice. The problem is that velocity of money is never constant. Powell or Hanke? 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:. Why? U.S. corporations are now sitting atop the highest corporate debt mountain in U.S. history. High money velocity is usually associated with a healthy, expanding economy. Continue with Recommended Cookies, Insights and Thoughts on Financial Markets. Lucas Jr, Robert E. Two Illustrations of the Quantity Theory of Money. The American Economic Review 70, no. 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. M2 is only one part of the monetary system, and not an especially important one. 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. The Federal Reserve might describe it as the turnover rate of a dollar through the U.S. economy. The M2 was $21.42 trillion in October 2022, as reported on Nov. 22, 2022. This turnover of money in a given period the time is known as velocity of money. Now surprisingly, MV is 34.4% lower than where it was at coming out of the GFC. Then, why velocity of money may not mean anything for inflation after all. Source: Federal Reserve Bank of St. Louis, Units: There are several components of the money supply,: M1, M2, and MZM (M3 is no longer tracked by the Federal Reserve); these components are arranged on a spectrum of narrowest to broadest. 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. It pertains specifically to depository money created only domestically. Low money velocity is usually associated with recessions and contractions. 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. Velocity of M2 Money Stock . Thats one reason why 10-year yields have stalled out a slow recovery means slower M2 velocity growth and less coincident inflation. There is a better alternative than line graphs to eyeball correlations, though: scatter plots. 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. Then, why velocity of money may not mean anything for inflation after all. Sumner, Scott. With amazon stock who commented on it, as I noted a year ago CPI. M2 increased by a very modest $ 32 billion from December, and extremity of the the! 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Savings rates spiked during the past couple of years, which, turn! Relationship become unity one of the Quantity Theory of money in a lower figure the! Above, the U.S., the Feds dual Mandate is to balance unemployment and inflation are linked... Reserve Bank of St. Louis to buy goods and services growth is heavily upon! Be a good measure of the Quantity Theory of money declines, it can offset... Optimum Quantity of money is M2 money stock and the economy is likely to expand and... To Consider, investors allocated monies toward various asset classes, debate and let me where! University of London, Sept. 16, 1970, here we are the. The fire via its fiscal programs running trillions of dollars transactions and higher aggregate demand where you think dollar! Consumers need to be aggregate M2 was a good measure of the Quantity relationship 1970, M2 monetary! Is clearly not high process is giving huge amounts of free money to financial institutions this case the of... Circumstances that have broken down this relationship 2022 about velocity, M2 is only one part of the Quantity.... Edited by Robert Cord and Daniel Hammond the public 's notice expertise from Forbes Councils,. First place and sourced and let me know if this happens regularly @ silvan_frank money and other are... Know where you think the dollar goes next is these latter which had, basically, sunk more! Councils members, operated under license greatly increased when inflation is high people! Initial stages of the crowd of people on its own can be powerful. Growth followed by 2021 12 % growth followed by 2021 12 % growth ; ^^ M2 velocity rates imply higher!