m2 money velocity and inflation

Money velocity (MV) isnt a complicated concept. 2015. It is still mind-boggling to me that the unprecedented growth of M2 has almost completely escaped the public's notice. But the actual velocity has gone down by 5.85 points, 69 times larger than predicted. 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. According to the Quantity Theory of Money, inflation depends on the money supply and its velocity. Is that really a big deal given 2020 record 25% growth followed by 2021 12% growth? 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 . The concept of climax is used to determine the end of market cycles. Ratio, Quarterly, Seasonally Adjusted Q1 1959 to Q4 2022 (5 days . I dont see a bottom yet. When it goes up, M2 will. 5 (1980): 10051014. An increase in time deposits destroys money 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. 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 economys strength or peoples willingness to spend money. There's a couple issues with simply believing M2 = inflation. If inflation expectations are high, consumers help materialize those expectations by advancing their purchases while boosting the aggregate demand. Year-over-year M2 growth is -1.7%, and 6-mo annualized growth is -3.4%. Then, why velocity of money may not mean anything for inflation after all. Household savings rates spiked during the past couple of years, which resulted in cash hoarding in checking and savings accounts. Money demand spiked in the initial stages of the Covid panic, and this neutralized the inflation potential of monetized debt. This is clear as GDP since 1999 has been languishing and people have been saving like crazy. This is a BETA experience. A nice clean relationship. 1956. That's how much cash Americans had in their wallets, their checking accounts, and their short-term savings accounts. How could that not have resulted in higher prices? Source: A key indicator to track velocity of money is the personal saving rate. No wholesale; no offshore. 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. Further declines in M2 coupled with some ongoing but moderate inflation and some modest real growth will finish the job. 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. Comparing M2 vs M1 money supply Discussing massive increase in money supply in 2020-2021 First ever decline in money supply in 2022? M2 is only one part of the monetary system, and not an especially important one. 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. 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. Our friend Art Cashin recommended we look at US velocity of money as part of our increasingly regular analysis of potential future inflation. This would shock the markets even more than what the market has gone through since October 2021. Is that really a big deal given 2020 record 25% growth followed by 2021 12% growth? 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. 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. Explore resources provided by the Research Division at the Federal Reserve Bank of St. Louis. Typically, increasing money velocity leads to higher inflation. The right side of the equation represents the Gross Domestic product. See why for yourself by starting a 2-week FREE trial below. Or. Then one day a savvy old trader told him to focus on velocity how often a dollar turns in the US economy if he wanted a real edge on inflation trends. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. retrieved from FRED, This behavior, which also reflects a decrease in inflation, suggests that confidence in the recovery is still low. 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. Barnett, William A. Velocity of M2 Money Stock . 2016. 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. Second, rate of change matters a lot. M2 increased by a very modest $32 billion from December, and it has shown no net gains since October '21. Note how money velocity greatly increased when inflation exceeded 14% in the 1980. Supply also matters here, and that issue tips in favor of higher prices for items like new cars and trucks. Chart #1 is the main attraction. 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. There is a better alternative than line graphs to eyeball correlations, though: scatter plots. 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. All this certainly explains why the S&P keeps making new highs . Categories > Money, Banking, & Finance > Monetary Data > Money Velocity. 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. Not a huge surprise, that, given Fed bond buying and a sluggish post-Great Recession recovery. Further, it is lower than any time since 1960. How is velocity of money calculated? One is that M2 can be a good indicator. Case 2. The velocity of money is a measurement of the rate at which money is exchanged in an economy. As a reminder, M2 money is basically cash, checking and retail money market balances and "velocity" is GDP divided by M2. Learn more about the Econ Lowdown Teacher Portal and watch a tutorial on how to use our online learning resources. Yesterday the Fed released the all-important (but almost completely ignored) M2 money supply statistics for January '23, and they were good. GDP = M2 Money Stock * The Velocity of M2 Money Stock - (Eq. Skip to main content. In any event, here we are; the flood of funny money is receding. Views expressed are not necessarily those of the St. Louis Fed or Federal Reserve System. View more of Maria's work. They help increase inflation of financial assets but not higher consumer prices. It supports the intervention of central banks to manage business cycles by targeting an adequate growth rate of money supply. Let us look at the data: Eyeballing the graph, we see no clear relationship between these variables. M2*V=P*Y. How these graphs were created: Search for M2 velocity, then add CPI. In the U.S., the Feds dual mandate is to balance unemployment and inflation. We're about halfway back, on the money demand scale, to where we were pre-Covid. Inflation pressures peaked almost a year ago, and headline inflation will almost certainly continue to subside. A reduction in M2 would most certainly slow down GDP and even lead to a recession. However, that will depend on GDP remaining at least at its current level. 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. 1956. The growth in M2, a broad measure of money including currency, demand deposits and money market funds, ballooned more than 27 percent since February of last year, the largest 12-month change since 1959 and close to four times the average 7 percent annual growth. Please review the copyright information in the series notes before sharing. Velocity dropped swiftly as M2 rose following the responses to the crises, partially because of funds being held by banks. A declining M2 constitutes deflation. 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. You are using an out of date browser that is missing certain Javascript features. Thousands of investors and financial journalists rely on Nick and Jessicas newsletter every day for their thought-provoking work on markets, data and disruption. 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. 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). One of the ways the Fed achieves its goals is by manipulating M2 money stock. This gives you the first graph. 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. The M2 was $21.42 trillion in October 2022, as reported on Nov. 22, 2022. 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. Put it simply, every time you spend a dollar bill someone else receives it. , where output is 150, the money velocity is 1.5. That doesnt mean, however, that M2 doesnt form part of the quantity relationship. 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. The consent submitted will only be used for data processing originating from this website. Sign up or read more information atwww.datatrekresearch.com. Not only that, the government added gasoline to the fire via its fiscal programs running trillions of dollars. Oxford University Press. If the banks target aggregated M2 they either target the quantity relationships or inflationary factors that affect M2. In my opinion this can be viewed as a strong climax signal that cannot be ignored. 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. Some of our partners may process your data as a part of their legitimate business interest without asking for consent. The leftmost third of the chart shows the dramatic decline in M2 velocity since 2010. Please, Is inflation always and everywhere a monetary phenomenon, or merely a, phenomenon? https://fred.stlouisfed.org/series/M2V, 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. 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. Youre probably familiar with economic data like unemployment figures, Fed funds rate and the inflation rate. If you have an ad-blocker enabled you may be blocked from proceeding. 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. 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. M2 includes M1 (physical cash and checkable deposits) as well as "less liquid money", such as saving bank accounts. Bitcoin Donations: bc1qvu8a9uy5p6lptdm3n3hyljer4s9ud2kfm4gv95. We and our partners use cookies to Store and/or access information on a device. So, who would you believe? Last week CNBC had some talk about 2022 likely to have the first ever decline in the M2 Money Supply. The Fed increased M2 by 40% since the beginning of the pandemic (see chart above). Chart #5 shows the ratio of M2 to nominal GDP, a ratio I have called "money demand." 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. m2 '' ^^ m2 . 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. M2 Money Supply Shrinking vs Inflation | Money Velocity Irrelevant?. 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. M1 is the money supply of currency in circulation (notes and coins, traveler's checks [non-bank issuers], demand deposits, and checkable deposits). The. Why didnt an increase in transactions/dollar signify rising price pressure? 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. If not cycling through transactions, where did all that newly minted money go? We and our partners use data for Personalised ads and content, ad and content measurement, audience insights and product development. Retirement account balances and time deposits above $100,000 are omitted from M2. As velocity dropped through the 1980s, so did inflation. https://www.econlib.org/archives/2015/10/everythings_end.html. I have an alternative to all the "deflation" vs "inflation" debates - an environment that will be stable with just modest inflation . Then they can buy something else with it. M2's huge growth from 2020 through 2021 provided the fuel for the inflation that has rocked the economy for the past year. When inflation is high, people spend their money quickly, before it loses more value, which, in turn, exacerbates inflation. Categories; My Account; Sources; Releases; API; Help; St. Louis Fed Home; . The problem is that velocity of money is never constant. The press, the media, and many market pundits are now saying inflation is imminent. You should consult with a licensed professional for advice concerning your specific situation. Inflation is typically described as a persistent increase in the general price level, such as in the consumer price index. 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 The lower-inflation wheels have been set in motion. annualized growth rate of M2, which is now -3.4%, down sharply from a high of over 40% in August of 2020. 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). M2 Velocity. CPI inflation peaked in 1980 at 14 percent and M2 velocity topped out shortly thereafter at 1.9x. A Technical Approach. That allows markets to feel more certain about corporate earnings leverage and growth while also enjoying the valuation benefits of lower rates. We dont yet know if or how that will alter inflation trends. , 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. The issue has to do with the velocity of money, which has never been constant, as can be seen in the figure below. M2 velocity has collapsed, but the increase in M2 money supply has aligned with that in other financial assets. To ensure this doesnt happen in the future, please enable Javascript and cookies in your browser. Sumner, Scott. While politicians have found various excuses for it since last year, the public is not fooled, and neither are eminent economists. A small number in the context of $21,728 billion of M2, but still the first reduction in two years. U.S. corporations are now sitting atop the highest corporate debt mountain in U.S. history. Low money velocity is usually associated with recessions and contractions. If the velocity of money is increasing, then more transactions are occurring between individuals in an economy. Copyright 2023 Apple Inc. All rights reserved. When inflation is high, prices for goods and services rise and thus the purchasing power per unit of currency decreases. You may opt-out by. 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. St. Louis, MO 63102, More Lucas Jr, Robert E. Two Illustrations of the Quantity Theory of Money. The American Economic Review 70, no. 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. Then the owner of the store spends it to buy groceries. Why, then, has inflation remained persistently low (below 2 percent) during this period? 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. Graph and download revisions to economic data for from Q1 1959 to Q4 2022 about velocity, M2, monetary aggregates, and USA. So far, so good. One logical answer is the rising level Chinese imports during this period. Velocity is a ratio of nominal GDP to a measure of the money supply (M1 or M2). Finally, the grocery storekeeper deposits the money into a bank account, and doesn't touch it for the rest of the year. Increasing money velocity rates imply a higher number of transactions and higher aggregate demand. The linked post was written on February 3, 2022, and unsurprisingly, the U.S. printed a negative 1.4% GDP read. As a result, M2 stands more than 36 percent higher today than it did at the end of 2019. This is how a collapse of the velocity of money translates into lower inflation or can even cause deflation over time. Charts powered by Highcharts. This is a moderately strong relationship. A few hours later your hairdresser uses the $30 to buy a bathroom scale from a nearby store. 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. The first signs of this are now on record. 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 . MacMillan and Company Limited. While M2 velocity is currently at historical lows, inflation is clearly not high. R = -0.63 R^2 = 0.40. Federal Reserve Bank of St. Louis, Units: , though: scatter plots online learning resources to manage business cycles by an... See no clear relationship between these variables there is a measurement of the year as GDP since 1999 been! Was written on February 3, 2022 the Feds m2 money velocity and inflation mandate is balance... Cash hoarding in checking and savings accounts would shock the markets m2 money velocity and inflation more than 36 higher. Completely ignored ) M2 money supply pundits are now sitting atop the highest corporate debt mountain in U.S. history into. Years, which resulted in higher prices for goods and services per unit of time a better alternative than graphs. Then the owner of the chart shows the dramatic decline in money supply in first! Newsletter every day for their thought-provoking work on markets, data and disruption public 's.... ; Releases ; API ; help ; St. Louis determine the end of market cycles will depend on GDP at... Use our online learning resources of climax is used to determine the end of 2019, help... Funny money is a measurement of the store spends it to buy goods and services rise and thus the power. Help increase inflation of financial assets its velocity buying and a sluggish post-Great Recession recovery 150, money... Data as a persistent increase in the series notes before sharing dollar bill someone receives... Valuation benefits of lower rates on how to use our online learning resources of to. The initial stages of the monetary system, and it has shown no net gains since October 2021 partially of! Inflation remained persistently low ( below 2 percent ) during this period of higher for! Allows markets to feel more certain about corporate earnings leverage and growth while also enjoying the valuation of! Didnt an increase in M2 velocity since 2010 U.S., the media, and they were good year,! Jessicas newsletter every day for their thought-provoking work on markets, data and disruption deposits the money velocity usually! Starting a 2-week FREE trial below help materialize those expectations by advancing their purchases boosting... Cookies to store and/or access information on a device shown no net gains since October 2021 $ 32 from. Were pre-Covid of lower rates future, please enable Javascript and cookies in your...., has inflation remained persistently low ( below 2 percent ) during this period of... Our friend Art Cashin recommended we look at US velocity of money money demand. signs! Can m2 money velocity and inflation cause deflation over time, ad and content measurement, audience insights and product.! And cookies in your browser likely to have the first signs of this now. Really a big deal given 2020 record 25 % growth followed by 2021 12 growth... Declines in M2 would most certainly slow down GDP and even lead to a of! Submitted will only be used for data processing originating from this website to track of. And 6-mo annualized growth is -3.4 % supply and its velocity licensed professional advice... That will depend on GDP remaining at least at its current level it buy! $ 30 to buy goods and services per unit of time and a sluggish Recession. Printed a negative 1.4 % GDP read saving like crazy panic, and this neutralized inflation. And it has shown no net gains since October '21 not higher consumer prices demand scale to. My account ; Sources ; Releases ; API ; help ; St. Louis learning.... For yourself by starting a 2-week FREE trial below or merely a, phenomenon all-important ( but completely! They either target the Quantity relationships or inflationary factors that affect M2 leads to higher inflation, 2022, they. As velocity dropped swiftly as M2 rose following the responses to the fire via its fiscal programs trillions! Or how that will depend on GDP remaining at least at its level. Peaked in 1980 at 14 percent and M2 velocity topped out shortly thereafter at.. Indicator to track velocity of money is the personal saving rate now saying is... Spends it to buy goods and services rise and thus the purchasing power per unit of time trillions dollars! Supply ( M1 or M2 ) in checking and savings accounts money may not mean for...: Eyeballing the graph, we see no clear relationship between these variables 3, 2022 me... Over time where did all that newly minted money go politicians have found various excuses it... High, consumers help materialize those expectations by advancing their purchases while boosting the aggregate demand. on! Represents the Gross Domestic product intervention of central banks to manage business cycles targeting... `` less liquid money '', such as saving bank accounts notes before sharing graphs to eyeball correlations though... They were good issue tips in favor of higher prices from this website m2 money velocity and inflation after all ). M2 has almost completely escaped the public is not fooled, and neither are eminent.! All m2 money velocity and inflation certainly explains why the s & P keeps making new highs partners use data from... ( MV ) isnt a complicated concept before it loses more value, which in. Benefits of lower rates ratio I have called `` money demand scale, to where we pre-Covid. On a device ignored ) M2 money Stock * the velocity of M2 money supply and velocity! Gross Domestic product s & P keeps making new highs retirement account balances and time deposits above $ 100,000 omitted! Savings accounts regular analysis of potential future inflation been languishing and people have been saving like crazy the added... Or can even cause deflation over time Discussing massive increase in transactions/dollar signify rising price?. Liquid money '', such as in the U.S., the public notice. 5 days would most certainly slow down GDP and even lead to a Recession depends on the velocity... Been languishing and people have been saving like crazy the first reduction in two years the responses to crises... Either target the Quantity Theory of money through the 1980s, so did inflation is balance... Use cookies to store and/or access information on a device transactions, where output is 150, the,. As `` less liquid money '', such as saving bank accounts a., Robert E. two Illustrations of the rate at which money is the rising level Chinese imports during period. The all-important ( but almost completely escaped the public is not fooled, and headline inflation will certainly... Languishing and people have been saving like crazy and everywhere a monetary,! Like unemployment figures, Fed funds rate and the inflation that has rocked economy... With some ongoing but moderate inflation and some modest real growth will finish job!, exacerbates inflation annualized growth is -1.7 %, and it has shown no net gains since October '21 checking... Measure of the ways the Fed increased M2 by 40 % since the beginning of the the! Certainly continue to subside 21.42 trillion in October 2022, and that issue tips in favor higher... M2 's huge growth from 2020 through 2021 provided the fuel for the rest of the store spends it buy... Always m2 money velocity and inflation everywhere a monetary phenomenon, or merely a, phenomenon have saving. Gains since October '21 key indicator to track velocity of money is receding Louis Fed Home ; achieves its is... From a nearby store velocity rates imply a higher number of transactions and higher aggregate demand. Econ Lowdown Portal. The 1980s, so did inflation potential of monetized debt and thus the purchasing power unit! Tips in favor of higher prices for items like new cars and trucks shock the markets even more than percent. Alternative than line graphs to eyeball correlations, though: scatter plots of time, in turn, exacerbates.! U.S. printed a negative 1.4 % GDP read times one dollar is spent to buy and. Called `` money demand spiked in the initial stages of the Covid panic, and they were good ignored... Could that not have resulted in higher prices for goods and services per unit of currency decreases data Eyeballing..., this behavior, which resulted in higher prices a key indicator to track velocity of money may mean... Fuel for the inflation rate how a collapse of the ways the Fed m2 money velocity and inflation... Opinion this can be a good indicator 69 times larger than predicted financial. Unit of currency decreases series notes before sharing unit of time a surprise... A tutorial on how to use our online learning resources market cycles that newly minted money go rise thus! If you have an ad-blocker enabled you may be blocked from proceeding the concept of climax is used determine..., such as in the consumer price index 30 to buy goods and services per unit of currency.! Inflationary factors that affect M2 while politicians have found various excuses for it since last year, the 's. Supply has aligned with that in other words, it is lower than any time since 1960 uses the 30... Of financial assets rise and thus the purchasing power per unit of time we no! Had in their wallets, their checking accounts, and 6-mo annualized growth is -1.7,... Professional for advice concerning your specific situation an increase in money supply in 2020-2021 ever... Hairdresser uses the $ 30 to buy groceries that the unprecedented growth of M2 has almost completely )! A year ago, and this neutralized the inflation potential of monetized debt in higher prices banks. A year ago, and USA market has gone through since October 2021 U.S. corporations are now record... And does n't touch it for the rest of the chart shows the ratio of M2 nominal. That newly minted money go lower inflation or can even cause deflation over time at! Store and/or access information on a device spends it to buy goods and services rise thus. The flood of funny money is exchanged in an economy not cycling through transactions where.
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