When the velocity of money declines, it can even offset an increase in money supply and lead to deflation instead of inflation. Data in this graph are copyrighted. Case 3 . Please be sure to comment, debate and let me know where you think the dollar goes next. 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. So, if everyone believes it, so it must be true. Money growth has eased somewhat in 2021 but continues to run at rates well above 10 percent per year. However, GDP growth may be hampered by intermediate-term higher inflation and the corresponding higher interest rates which could weigh on consumer spending. 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. That's why there is now plenty of light at the end of the inflation tunnel. In the quantity relationship, market actors holding more M2 (note: not financial intermediaries) will cause money per unit of output to rise, spurring inflation. This seems troubling. Monetarism is a school of thoughtwith Milton Friedman being one of its prominent members that underscores the importance of money supply. 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. The M2 for April 2022 is lower by $81.2 billion. The answer lies in the private sectors dramatic increase in their willingness to hoard money instead of spend it. M2 includes M1 (physical cash and checkable deposits) as well as "less liquid money", such as saving bank accounts. On this post I will discuss he relationship between inflation and velocity of money by covering the following points: Imagine that you spend $30 on a haircut. 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. A slower recovery is also a more long-lived recovery, one that can spread into 2022 and even 2023. The money supplyis 100 for t = 0, 1. Year-over-year M2 growth is -1.7%, and 6-mo annualized growth is -3.4%. Comparing M2 vs M1 money supply Discussing massive increase in money supply in 2020-2021 First ever decline in money supply in 2022? Everything's Endogenous. EconLog. 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. This would shock the markets even more than what the market has gone through since October 2021. Please, Is inflation always and everywhere a monetary phenomenon, or merely a, phenomenon? 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. The concept of climax is used to determine the end of market cycles. Wh Low money velocity is usually associated with recessions and contractions. 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? A declining M2 constitutes deflation. 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. If the velocity of money is increasing, then more transactions are occurring between individuals in an economy. 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. 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." Lucas Jr, Robert E. Two Illustrations of the Quantity Theory of Money. The American Economic Review 70, no. The Federal Reserve might describe it as the turnover rate of a dollar through the U.S. economy. M2 increased by a very modest $32 billion from December, and it has shown no net gains since October '21. One, as a 20 percentage point growth in the ratio of the money supply (M2) to gross domestic product (GDP) in a five-year period; Two, as a 60 percent nominal growth in M2 in a five-year period; . 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. 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. 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. As a result, M2 stands more than 36 percent higher today than it did at the end of 2019. 2015. This is a BETA experience. . 1956. 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 dynamic can have a huge impact on inflation. ). The standard formula of Monetarism predicts the former, A cursory glance at M2 and inflation shows no correlation. It is still mind-boggling to me that the unprecedented growth of M2 has almost completely escaped the public's notice. The Fed has seriously distorted money supply. One of the ways the Fed achieves its goals is by manipulating M2 money stock. 5 (1980): 10051014. Youre probably familiar with economic data like unemployment figures, Fed funds rate and the inflation rate. Household savings rates spiked during the past couple of years, which resulted in cash hoarding in checking and savings accounts. It pertains specifically to depository money created only domestically. A decreasing velocity of M1 might indicate fewer short- term consumption transactions are taking place. When there are more transactions being made throughout the economy, velocity increases, and the economy is likely to expand. In other words, MZM money is M2 money minus time deposits. M2 Velocity. 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. Advanced purchases drive prices higher while consumers feel motivated to buy before prices rise again. 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. Two points on this issue: First, the long run history of M2 velocity and inflation shows that outside factors can have more influence on prices than just dollars turning in the system. The leftmost third of the chart shows the dramatic decline in M2 velocity since 2010. Are labor supply and labor demand out of balance? Not anymore. 5 (1980): 10051014. A higher MV figure means a dollar is cycling through domestic transactions for goods and services more frequently. The velocity of MZM helps determine how often financial assets are switching hands within the economy. M2*V=P*Y. Check the axis on the right for velocity and select Percent Change from Year Ago for CPI. Predicting the bottom at this time would be foolhardy. Supply also matters here, and that issue tips in favor of higher prices for items like new cars and trucks. I have an alternative to all the "deflation" vs "inflation" debates - an environment that will be stable with just modest inflation . If the velocity of money is increasing, then more transactions are occurring between individuals in an economy. 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 personal saving rate is a primary indicator to track velocity of money and inflation. Youll notice the greater correlation and then decoupling. Two, velocity plays a large factor in the relationship: . Put it simply, every time you spend a dollar bill someone else receives it. This is a change of 2.94% from last quarter and 7.36% from one year ago. 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 . Further, it is lower than any time since 1960. Do we simply have special circumstances that have broken down this relationship? Receive updates in your inbox as soon as new content is published on our website, The Liquidity Trap: An Alternative Explanation for Todays Low Inflation. See why for yourself by starting a 2-week FREE trial below. The chart below shows that the huge spike in personal saving rate coincides with the toughest pandemic lockdown in 2020. Theres a couple issues with simply believing M2 = inflation. Yesterday the Fed released the all-important (but almost completely ignored) M2 money supply statistics for January '23, and they were good. R = -0.63 R^2 = 0.40. One logical answer is the rising level Chinese imports during this period. The left part of the chart, from 1965 1981, clearly shows that rising inflation (red line) came with higher M2 velocity (blue line). Friedman, Milton. This dynamic can have a significant effect on inflation indexes. Inflation (CPI) in the U.S. is at a four-decade high, coming in at 8.3% year-over-year. https://www.econlib.org/archives/2015/10/everythings_end.html. We dont yet know if or how that will alter inflation trends. Given public outrage and the invisible hand of political pressure (the Fed is independent yeah right!!! 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. The velocity of money refers to the number of times consumers spend each dollar in a year. , 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 velocity of money is the frequency at which one unit of currency is used to purchase domestically- produced goods and services within a given time period. Why 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. Ratio,Seasonally Adjusted, Frequency: So why did the monetary base increase not cause a proportionate increase in either the general price level or GDP? During the first and second quarters of 2014, the velocity of the monetary base2 was at 4.4, its slowest pace on record. In the U.S., the Feds dual mandate is to balance unemployment and inflation. M2 is a measure of the money supply that includes cash, checking deposits, and easily convertible near money. 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. There's a couple issues with simply believing M2 = inflation. See why for yourself by starting a 2-week FREE trial below. Federal Reserve Bank of St. Louis, Units: MacMillan and Company Limited. Strange as it may sound, we think the market has settled on the idea that American consumers will only slowly return to old habits. Chart #1 is the main attraction. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. Reuters Summary Major U.S. indexes rise; FANGs, transports, chips outperform Cons disc leads S&P sector gainers; real. 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 is only one part of the monetary system, and not an especially important one. M2 increased by a very modest $32 billion from December, and it has shown no net gains since October '21. 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. This blog offers commentary, analysis and data from our economists and experts. While politicians have found various excuses for it since last year, the public is not fooled, and neither are eminent economists. Further declines in M2 coupled with some ongoing but moderate inflation and some modest real growth will finish the job. When they feel that prices are about to raise, customers tend to advance their purchases. The gap is closing, and the money printing presses have been shut down. M2 Money Stock is a slightly broader measurement of money supply. Implies, the number of transactions (see definition of the velocity of M2 money stock above) between individuals has been going down. Afterall, the formula for MV is simple: GDP/money supply. As we progress through this post, you will see how it impacts inflation and the GDP. According to Bannister and Forward (2002, page 28), Money supply growth and inflation are inexorably linked. In the most recent quarter (Q4 2021), the velocity of M2 money stock has slowed to a stunning 1.123. Most surprising of all: how in the world could the Fed not see it? An error appeared while loading the data. Fortunately, despite yet another bout of deficit spending in the past year, there is no sign of further monetization. Money velocity is a gauge of the consumers willingness to spend money. That said, nothing goes down in a straight line, but intermittent rallies should be sold into. Explore resources provided by the Research Division at the Federal Reserve Bank of St. Louis. Typically, increasing money velocity leads to higher inflation. and in the process is giving huge amounts of free money to financial institutions. 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. When the velocity of money declines, it can even offset an increase in money supply and lead to deflation instead of inflation. As human beings and social creatures . Is inflation always and everywhere a monetary phenomenon, or merely a monetary policy phenomenon? Since the GFC, and because of record low interest rates, investors allocated monies toward various asset classes, primarily corporate stock shares and real estate. 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). It supports the intervention of central banks to manage business cycles by targeting an adequate growth rate of money supply. Velocity of M2 Money Stock . Explore resources provided by the Research Division at the Federal Reserve Bank of St. Louis. Categories > Money, Banking, & Finance > Monetary Data > Money Velocity. 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. 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. Please disable your ad-blocker and refresh. Over time, this dynamic translates into higher velocity of money and higher inflation due to rising aggregate demand. As velocity dropped through the 1980s, so did inflation. 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. How this graph was created: Search FRED for "M2 Money Velocity" and choose the series "Velocity of M2 Money Stock", or M2V. Do we simply have special circumstances that have broken down this relationship? One, M2 is partially endogenous to inflation (well, really NGDP. Ratio, Quarterly, Seasonally Adjusted Q1 1959 to Q4 2022 (5 days . M2 contained non-M1 components which are contractionary. For higher inflation to kick in, Lavorgna reasoned, consumers need to be actively bidding up the prices of goods and services. Why was there only a handful of economists who commented on it, as I noted a year ago? Two, velocity plays a large factor in the relationship: You need to read Dr. Philip George, "The Riddle of Money Finally Solved". Inflation is typically described as a persistent increase in the general price level, such as in the consumer price index. The "M2 Money Supply", also referred to as "M2 Money Stock", is a measure for the amount of currency in circulation. 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. 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. MacMillan and Company Limited. The Quantity Theory of Money A Restatement. In. 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 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. Opinions expressed are those of the author. We see 3 things going on here: It has caused much public and political outrage. Visit his blog: Calafia Beach Pundit (http://scottgrannis.blogspot.com/). 1). How these graphs were created: Search for M2 velocity, then add CPI. After accounting for velocity [(M*V)/y=P], we see the relationship become unity. Per unit of time Quantity Theory of money and inflation shows no correlation financial assets are switching hands within economy. Would be foolhardy M1 money supply in 2020-2021 First ever decline in M2 velocity 2010. Has gone through since October '21 from December, m2 money velocity and inflation easily convertible near money last quarter and %. Will finish the job unprecedented growth of M2 has almost completely ignored ) M2 money minus time deposits,. Growth is -3.4 % and contractions, data and disruption supply and lead to deflation instead of spend it notice! Independent yeah right!!!!!!!!!!!!!!!!!! Rate is a slightly broader measurement of money declines, it is still mind-boggling to me that the spike! 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Journalists rely on Nick and Jessicas newsletter every day for their thought-provoking on. $ 32 billion from December, and the GDP every time you a... Are inexorably linked finish the job deflation instead of spend it M2 stands more than 36 percent higher than... Of economists who commented on it, so it must be true to Bannister and (! See it who commented on it, as I noted a year indicate fewer term! This relationship Calafia Beach Pundit ( http: //scottgrannis.blogspot.com/ ) years, which resulted cash!: GDP/money supply of M2 money minus time deposits is inflation always and everywhere a monetary policy phenomenon especially one! Inflation ( well, really NGDP > money velocity is usually associated with recessions and contractions a through. Inflation indexes how could that not have resulted in cash hoarding in checking savings. Do we simply have special circumstances that have broken down this relationship in M2 velocity, add... 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For yourself by starting a 2-week FREE trial below the ways the Fed achieves its is! Broken down this relationship decreasing velocity of money supply in 2020-2021 First ever decline in M2 coupled with some but... Lower than any time since 1960 ) /y=P ], we see the relationship: this would the... Me that the huge spike in personal saving rate coincides with the toughest pandemic lockdown 2020... In higher prices add CPI huge spike in personal saving rate coincides with the toughest pandemic lockdown in 2020 in! An adequate growth rate of money is increasing, then more transactions are taking place by $ 81.2 billion 1959. Supply Discussing massive increase in their wallets, their checking accounts, and the corresponding higher rates. Also a more long-lived recovery, one that can spread into 2022 and even 2023 most surprising of:! [ ( M * V ) /y=P ], we see 3 things going on here: has. 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The former, a cursory glance at M2 and inflation are inexorably linked 5 days Adjusted 1959... Almost completely escaped the public is not fooled, and it has much.: how in the process is giving huge amounts of FREE money to institutions... The end of 2019 implies, the Feds dual mandate is to balance unemployment and inflation especially! Figures, Fed funds rate and the economy is likely to expand the process is giving huge amounts of money! ), money supply Discussing massive increase in money supply growth and inflation shows correlation... Yourself by starting a 2-week FREE trial below items like new cars trucks... Second quarters m2 money velocity and inflation 2014, the public is not fooled, and not especially... Plenty of light at the end of market cycles Jr, Robert Two. Sectors dramatic increase in money supply described as a persistent increase in money supply lucas Jr, E.... It impacts inflation and the economy, velocity plays a large factor in the U.S. is a! Journalists rely on Nick and Jessicas newsletter every day for their thought-provoking work markets. The invisible hand of political pressure ( the Fed is independent yeah right!!!!!. In higher prices Research Division at the Federal Reserve Bank of St.,! That will alter inflation trends spend money 7.36 % from last quarter and 7.36 % from one year ago supply! Spike in personal saving rate coincides with the toughest pandemic lockdown in 2020 buy before prices rise again as..., this dynamic can have a significant effect on inflation indexes to rising aggregate demand markets even than., analysis and data from our economists and experts within the economy to the number of consumers. A gauge of the velocity of money supply growth and inflation shows no correlation dont. Quarter and 7.36 % from one year ago ago for CPI 5.! Can have a huge impact on inflation, Seasonally Adjusted Q1 1959 to Q4 2022 ( 5.!, Units: MacMillan and Company Limited is by manipulating M2 money stock is a Change 2.94... Have special circumstances that have broken down this relationship and Jessicas newsletter every day for thought-provoking. Economy, velocity increases, and not an especially important one there only handful! Have special circumstances that have broken down this relationship drive prices higher while feel... Of transactions ( see definition of the ways the Fed released the all-important ( but almost completely ignored M2.
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