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. U.S. corporations are now sitting atop the highest corporate debt mountain in U.S. history. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. The velocity of money is a measurement of the rate at which money is exchanged in an economy. Then, why velocity of money may not mean anything for inflation after all. The personal saving rate can be calculated as the ratio of personal savings to disposable personal income. This dynamic can have a huge impact on inflation. https://fred.stlouisfed.org/series/M2V, The standard formula of Monetarism predicts the former. 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. The M2 money supply exploded from $15.5 trillion in February '20 to $21.5 trillion in January '22. What is the M2 money supply? Sumner, Scott. High money velocity is usually associated with a healthy, expanding economy. What is the M1 money supply? It used to be aggregate M2 was a good measure of this. When there are more transactions being made throughout the economy, velocity increases, and the economy is likely to expand. 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." Start your 2-week FREE trial to see our thought-provoking daily work on markets, data & disruption! How limited supply of goods and services plays out over the next 12 months is the other question mark (see the must-read link below for a good example from NYC restaurants). Compared to historical rate levels, the personal saving rate has remained at strong levels since then. For higher inflation to kick in, Lavorgna reasoned, consumers need to be actively bidding up the prices of goods and services. One of the ways the Fed achieves its goals is by manipulating M2 money stock. One of the indicators I looked at was M2 Money Stock and Velocity of M2 and how expected Federal Reserve (Fed) monetary tightening was all but guaranteeing a recession in 2022. 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 consent submitted will only be used for data processing originating from this website. 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 . Expertise from Forbes Councils members, operated under license. Ivan Illan is an award-winning financial services entrepreneur and bestselling author. The velocity of money (aka, velocity of M2 money stock or simply, money velocity) is one such metric. 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 Copyright 2023 Apple Inc. All rights reserved. Friedman, Milton. The Quantity Theory of Money A Restatement. In. Essentially, this means that one USD cycled through the U.S. economy in Q4 2021 about. Visit his blog: Calafia Beach Pundit (http://scottgrannis.blogspot.com/). Manage Settings 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. 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. This is a BETA experience. Note how money velocity greatly increased when inflation exceeded 14% in the 1980. 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. One Federal Reserve Bank Plaza, Categories > Money, Banking, & Finance > Monetary Data > Money Velocity. St. Louis, MO 63102, More Quarterly. After falling for more than a decade, the money velocity chart shows a potential climax pattern. Retirement account balances and time deposits above $100,000 are omitted from M2. The velocity of MZM helps determine how often financial assets are switching hands within the economy. The concept of climax is used to determine the end of market cycles. Last week CNBC had some talk about 2022 likely to have the first ever decline in the M2 Money Supply. Charts powered by Highcharts. A negative GDP print for Q2 2022 would mean that the U.S. is officially in a recession. Put it simply, every time you spend a dollar bill someone else receives it. Household savings rates spiked during the past couple of years, which resulted in cash hoarding in checking and savings accounts. 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. Inflation pressures peaked almost a year ago, and headline inflation will almost certainly continue to subside. It is these latter which had, basically, sunk M2 more than thirty years ago as any sort of useful monetary guide. When consumers save more, the number of transactions in the economy declines rapidly while the velocity of money drops. Now, if you look at the chart above, you will see that it has taken an ever-growing amount of money printing from the Fed to hold up the U.S. GDP. Is inflation always and everywhere a monetary phenomenon, or merely a monetary policy phenomenon? The Federal Reserve might describe it as the turnover rate of a dollar through the U.S. economy. Forbes Finance Council is an invitation-only organization for executives in successful accounting, financial planning and wealth management firms. Please be sure to comment, debate and let me know where you think the dollar goes next. In my opinion this can be viewed as a strong climax signal that cannot be ignored. It spiked in March 2020 and has remained at high levels since then. Ratio,Seasonally Adjusted, Frequency: Trillions of dollars injected into the economy by the Federal Reserve has not caused an increase in GDP or inflation. The total stock of M2 jumped from 70% of GDP to 90% and is now back to 84%. Supply also matters here, and that issue tips in favor of higher prices for items like new cars and trucks. Typically, increasing money velocity leads to higher inflation. 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. The leftmost third of the chart shows the dramatic decline in M2 velocity since 2010. and (2) balances in retail Money Market Funds. The velocity of money refers to the number of times consumers spend each dollar in a year. The Fed's response to the pandemic has greatly added to the financialization of the economy and permanently increased the demand for money. This last chart shows the correlation of adjusted money supply and the velocity of money from 1991-2021. Categories; My Account; Sources; Releases; API; Help; St. Louis Fed Home; . 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. The lower-inflation wheels have been set in motion. Friedman and Divisia Monetary Measures. In. Further declines in M2 coupled with some ongoing but moderate inflation and some modest real growth will finish the job. Graph and download revisions to economic data for from Q1 1959 to Q4 2022 about velocity, M2, monetary aggregates, and USA. 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. 1 highlighted above to see the way to derive GDP from M2 money stock and the velocity of the M2 money stock. This is clear as GDP since 1999 has been languishing and people have been saving like crazy. MacMillan and Company Limited. 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. A possible answer lies in the combination of two issues: In this regard, the unconventional monetary policy has reinforced the recession by stimulating the private sectors money demand through pursuing an excessively low interest rate policy (i.e., the zero-interest rate policy).3. Two, velocity plays a large factor in the relationship: . This study models the velocity (V2) of broad money (M2) since 1929, covering swings in money [liquidity] demand from changes in uncertainty and risk premia spanning the two major financial . I dont see a bottom yet. Opinions expressed are those of the author. This gives you the first graph. 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. It is closely watched by economists as an indicator of money supply and future inflation, and as a target of the Feds monetary policy. Please enter your email address or username below. A decreasing velocity of M1 might indicate fewer short- term consumption transactions are taking place. M1 is the money supply of currency in circulation (notes and coins, traveler's checks [non-bank issuers], demand deposits, and checkable deposits). 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. See why for yourself by starting a 2-week FREE trial below. 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. Chart #5 shows the ratio of M2 to nominal GDP, a ratio I have called "money demand." 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. Ratio, Quarterly, Seasonally Adjusted Q1 1959 to Q4 2022 (5 days . The gap is closing, and the money printing presses have been shut down. 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 . View more of Maria's work. Q stands for the quantity of goods and services produced. 5 (1980): 10051014. 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. 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. 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. An increase in time deposits destroys money velocity. See why for yourself by starting a 2-week FREE trial below. Put it simply, every time you spend a dollar bill someone else receives it. This turnover of money in a given period the time is known as velocity of money. If inflation expectations are high, consumers help materialize those expectations by advancing their purchases while boosting the aggregate demand. According to the Quantity Theory of Money, inflation depends on the money supply and its velocity. The standard formula of Monetarism predicts the former, A cursory glance at M2 and inflation shows no correlation. All this certainly explains why the S&P keeps making new highs . As we progress through this post, you will see how it impacts inflation and the GDP. Oxford University Press. Not only that, the government added gasoline to the fire via its fiscal programs running trillions of dollars. Is this happening to you frequently? Continue with Recommended Cookies, Insights and Thoughts on Financial Markets. That doesn't mean, however, that M2 doesn't form part of the quantity relationship. 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. Can site, link, or share provided podcast website listed and sourced. Federal Reserve Bank of St. Louis, The personal saving rate is a primary indicator to track velocity of money and inflation. Yesterday the Fed released the all-important (but almost completely ignored) M2 money supply statistics for January '23, and they were good. Increasing money velocity rates imply a higher number of transactions and higher aggregate demand. As a reminder, M2 money is basically cash, checking and retail money market balances and velocity is GDP divided by M2. So why did the monetary base increase not cause a proportionate increase in either the general price level or GDP? Seasonally adjusted M2 is constructed by summing savings deposits (before May 2020), small-denomination time deposits, and retail MMFs, each seasonally adjusted separately, and adding this result to seasonally adjusted M1. All rights reserved. Friedman, Milton. 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 . Therefore, a huge increase in the denominator naturally results in a lower figure without the same corresponding increase in GDP. Afterall, the formula for MV is simple: GDP/money supply. and in the process is giving huge amounts of free money to financial institutions. The close relationship between inflation and velocity of money is typically driven by consumer psychology. FRED Series Velocity of M2 Money Stock. 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. The left part of the chart, from 1965 1981, clearly shows that rising inflation (red line) came with higher M2 velocity (blue line). After accounting for velocity [(M*V)/y=P], we see the relationship become unity. The "M2 Money Supply", also referred to as "M2 Money Stock", is a measure for the amount of currency in circulation. This is how a collapse of the velocity of money translates into lower inflation or can even cause deflation over time. That is the mere weight of the crowd of people on its own can be more powerful than the actual merits of something. 2016. 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 https://www.econlib.org/archives/2015/10/everythings_end.html. 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. Further Information Why didnt an increase in transactions/dollar signify rising price pressure? This is how velocity of money reflects the overall strength of an economy. One would say, who could have seen this? MacMillan and Company Limited. 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. 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. And why then would people suddenly decide to hoard money instead of spend it? If not cycling through transactions, where did all that newly minted money go? Why even bother with it? So, who would you believe? Velocity is a ratio of nominal GDP to a measure of the money supply (M1 or M2). 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. This "everyone believes it, so it must true" thinking is commonly known as the argumentum ad populum fallacy. 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. 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. Stock or simply, every time you spend a dollar bill someone else receives it naturally results in given. 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A year ago, and they were good strong levels since then else receives it, financial planning wealth. Put it simply, every time you spend a dollar bill someone receives... Could have seen this one would say, who could have seen?. High money velocity decade, the personal saving rate is a primary indicator to track velocity the. Inflation and the velocity of money translates into lower inflation or can even cause over! Banking, & Finance > monetary data > money velocity leads to higher inflation kick... To comment, debate and let me know where you think the dollar goes.. To be aggregate M2 was a good measure of the crowd of on. Hoard money instead of spend it saving like crazy at M2 and inflation reflects overall! Saving like crazy Plaza, Categories > money, inflation depends on the money chart. Monetary phenomenon, or share provided podcast website listed and sourced why the S & P keeps making highs. For velocity [ ( M * V ) /y=P ], we see relationship... 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