M2*V=P*Y. M2 Velocity. When consumers save more, the number of transactions in the economy declines rapidly while the velocity of money drops. 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 CPI inflation peaked in 1980 at 14 percent and M2 velocity topped out shortly thereafter at 1.9x. This last chart shows the correlation of adjusted money supply and the velocity of money from 1991-2021. 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. Maybe there is a technical problem with the data source. There's a couple issues with simply believing M2 = inflation. Friedman and Divisia Monetary Measures. In. 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. This site requires JavaScript to run correctly. It pertains specifically to depository money created only domestically. ), the Fed has finally pivoted, albeit painfully slowly. 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. So why did Milton Friedman, the greatest monetary economist barring perhaps Wicksell, choose to use M2 as his measure? Technical analysis can be applied on economic indicators whenever human psychology plays a key role. High money velocity is usually associated with a healthy, expanding economy. While politicians have found various excuses for it since last year, the public is not fooled, and neither are eminent economists. This is a BETA experience. What is the M2 money supply? That's how much cash Americans had in their wallets, their checking accounts, and their short-term savings accounts. m2 6 r^2 = 0.0259. 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. Not really, I had given a blanket sell call in late September 2021 and even did so again in January 2022. Federal Reserve Bank of St. Louis, Units: 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). That is the mere weight of the crowd of people on its own can be more powerful than the actual merits of something. Strange as it may sound, we think the market has settled on the idea that American consumers will only slowly return to old habits. You are using an out of date browser that is missing certain Javascript features. Two, velocity plays a large factor in the relationship: 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. ). Why even bother with it? Velocity of M2 Money Stock. The M2 money supply grew at annualized rates exceeding 20 percent throughout much of 2020. When there are more transactions being made throughout the economy, velocity increases, and the economy is likely to expand. 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. Then they can buy something else with it. Data in this graph are copyrighted. Forbes Finance Council is an invitation-only organization for executives in successful accounting, financial planning and wealth management firms. , edited by Robert Cord and Daniel Hammond. In the most recent quarter (Q4 2021), the velocity of M2 money stock has slowed to a stunning 1.123. The issue has to do with the velocity of money, which has never been constant, as can be seen in the figure below. Money, no matter how much may be in the system, doesnt translate into inflation if it just sits in the bank collecting dust. 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. In the quantity relationship, market actors holding more M2 (note: not financial intermediaries) will cause money per unit of output to rise, spurring inflation. Are labor supply and labor demand out of balance? 2015. Simply because instead of consuming, the private sector has been hoarding money and financial assets while velocity of money has been dropping persistently for almost two decades. We explore the stock, flow and velocity of money, as well as signs of weakening aggregate demand, in this week's note. A slower recovery is also a more long-lived recovery, one that can spread into 2022 and even 2023. Velocity of M2 Money Stock [M2V], Further declines in M2 coupled with some ongoing but moderate inflation and some modest real growth will finish the job. Monetarism is a school of thoughtwith Milton Friedman being one of its prominent members that underscores the importance of money supply. Friedman, Milton. 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. M2 increase of 20% to GDP followed by 5 years of 5% inflation. All this certainly explains why the S&P keeps making new highs . 1956. 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. All rights reserved. Not anymore. This dynamic can have a significant effect on inflation indexes. m2 '' ^^ m2 . It used to be aggregate M2 was a good measure of this. 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. When inflation is high, people spend their money quickly, before it loses more value, which, in turn, exacerbates inflation. 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. Why didnt an increase in transactions/dollar signify rising price pressure? Thus followed a surge in spending at a time of supply chain shortages, and it all came together to create a perfect wave of higher inflation. One logical answer is the rising level Chinese imports during this period. Source: Why? Summing up: as we keep after the inflation topic and look at it from more perspectives, all roads lead to that rate of change point. Amazon Return To Office Mandate, And Whats Happening With Amazon Stock? We and our partners use cookies to Store and/or access information on a device. Or. The Fed increased M2 by 40% since the beginning of the pandemic (see chart above). So far, so good. It is closely watched by economists as an indicator of money supply and future inflation, and as a target of the Feds monetary policy. annualized growth rate of M2, which is now -3.4%, down sharply from a high of over 40% in August of 2020. This turnover of money in a given period the time is known as velocity of money. Chart #2 shows the 6-mo. While M2 velocity is currently at historical lows, inflation is clearly not high. For higher inflation to kick in, Lavorgna reasoned, consumers need to be actively bidding up the prices of goods and services. Historical Statistics of the United States, Colonial Times to 1970, M2 Money Stock until 1959, Chapter X, pages 992-993. The big question, of course, is whether record low money velocity in 2021 (just 1.1x in Q4 2020) is a sign that inflation will remain low going forward or will the inevitable snapback in GDP/systemwide cash bring with it rising prices. 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 personal saving rate can be calculated as the ratio of personal savings to disposable personal income. 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. An increase in time deposits destroys money velocity. Sumner, Scott. Everything's Endogenous., Barnett, William A. As a reminder, M2 money is basically cash, checking and retail money market balances and velocity is GDP divided by M2. 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. The Counter-Revolution in Monetary Theory, Wincott Memorial Lecture, University of London, Sept. 16, 1970. Youll notice the greater correlation and then decoupling. 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). Copyright Broken Pie Chart Podcast. 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. After accounting for velocity [(M*V)/y=P], we see the relationship become unity. The charts below illustrate this point. 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. How these graphs were created: Search for M2 velocity, then add CPI. 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. One, M2 is partially endogenous to inflation (well, really NGDP). It's a psychological, self-reinforcing process. This dynamic can have a huge impact on inflation. CRN202504-2146319. LIVE MARKETS Will money velocity be a bigger inflation factor in 2022? Supply also matters here, and that issue tips in favor of higher prices for items like new cars and trucks. 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. U.S. corporations are now sitting atop the highest corporate debt mountain in U.S. history. The second is that Friedman preferred the divisia of M2. Year-over-year M2 growth is -1.7%, and 6-mo annualized growth is -3.4%. 1). M2's huge growth . Continue with Recommended Cookies, Insights and Thoughts on Financial Markets. The Fed's response to the pandemic has greatly added to the financialization of the economy and permanently increased the demand for money. By the end of that year, M2 totaled . When the frequency of transactions increases, the velocity of money rises. When it goes up, M2 will. https://www.econlib.org/archives/2015/10/everythings_end.html. 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. Increasing money velocity rates imply a higher number of transactions and higher aggregate demand. Household savings rates spiked during the past couple of years, which resulted in cash hoarding in checking and savings accounts. As we progress through this post, you will see how it impacts inflation and the GDP. 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). Is inflation always and everywhere a monetary phenomenon, or merely a monetary policy phenomenon? 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? And inflation was lower in the 2010s than any prior period, but that feels more like correlation with declining money supply than direct causation. Note how money velocity greatly increased when inflation exceeded 14% in the 1980. Not only that, the government added gasoline to the fire via its fiscal programs running trillions of dollars. Some of our partners may process your data as a part of their legitimate business interest without asking for consent. How is velocity of money calculated? 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; . The information provided here is not investment, tax or financial advice. 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 . These put persistent pressure on prices. 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. M2 is a measure of the money supply that includes cash, checking deposits, and easily convertible near money. That is what happened in the 1990s. and (2) balances in retail Money Market Funds. 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. One, M2 is partially endogenous to inflation (well, really NGDP. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. When the velocity of money declines, it can even offset an increase in money supply and lead to deflation instead of inflation. In my opinion this can be viewed as a strong climax signal that cannot be ignored. However, that will depend on GDP remaining at least at its current level. Check the axis on the right for velocity and select Percent Change from Year Ago for CPI. 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 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. Low money velocity is usually associated with recessions and contractions. The problem is that velocity of money is never constant. Those are important but dont necessarily tell the whole story on the state of the economy, much less the direction to which things may be headed. You should consult with a licensed professional for advice concerning your specific situation. Thats one reason why 10-year yields have stalled out a slow recovery means slower M2 velocity growth and less coincident inflation. Tech Hiring Freeze and Lay Offs Accelerate, Chinese Companies Could be Delisted in 2023 as HK and US Rescind Accounting Pact, M2 Money Stock and Velocity of M2 and how expected Federal Reserve (Fed) monetary tightening was all but guaranteeing a recession in 2022, outspoken critic of the Fed and its failure to foresee that the exploding M2 would cause inordinately high inflation. When they feel that prices are about to raise, customers tend to advance their purchases. A Fed pivot to hawkishness, even before any tightening, has caused carnage in high-growth high-flying tech stocks. Then the owner of the store spends it to buy groceries. 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 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. Series from Money Velocity. The monetary base includes notes and coins in circulation as well as bank reserves. Please update to a modern browser: a list is available here. My R^2 was 0.754. You may opt-out by. Please enter your email address or username below. V stands for the velocity of money (or the rate at which people spend money). Views expressed are not necessarily those of the St. Louis Fed or Federal Reserve System. Monetary expansion policies do not necessarily increase the velocity of money. Inflation expectations today are consistent with inflation falling to the Fed's target of 2% within the next 9-12 months, as Chart #6 shows. 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. retrieved from FRED, Finally, the grocery storekeeper deposits the money into a bank account, and doesn't touch it for the rest of the year. This would shock the markets even more than what the market has gone through since October 2021. Chart #5 shows the ratio of M2 to nominal GDP, a ratio I have called "money demand." That's why there is now plenty of light at the end of the inflation tunnel. Comparing M2 vs M1 money supply Discussing massive increase in money supply in 2020-2021 First ever decline in money supply in 2022? 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 press, the media, and many market pundits are now saying inflation is imminent. Are you sure you want to remove this series from the graph? St. Louis, MO 63102, More Prior to joining Western Asset, he was Senior Economist at the Claremont Economics Institute, an economic forecasting and consulting service headed by John Rutledge, from 1980 to 1986. 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 . Manage Settings One Federal Reserve Bank Plaza, In the case of a downtrend, the climax is characterized by a sharp decline after the mature part of an extended downturn. Categories > Money, Banking, & Finance > Monetary Data > Money Velocity. Inflation pressures peaked almost a year ago, and headline inflation will almost certainly continue to subside. 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 lower-inflation wheels have been set in motion. 2022 DataTrek Research, LLC provides a daily market insight newsletter, as well as other services, through its site at www.datatrekresearch.com. 2016. He specialized in analysis of Federal Reserve policy and interest rate forecasting, and spearheaded the firm's research into Treasury Inflation Protected Securities (TIPS). Consider M1, the narrowest component. That said, nothing goes down in a straight line, but intermittent rallies should be sold into. Further Information Therefore, a huge increase in the denominator naturally results in a lower figure without the same corresponding increase in GDP. 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. 2). 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. M2 increased by a very modest $32 billion from December, and it has shown no net gains since October '21. Why, then, has inflation remained persistently low (below 2 percent) during this period? Expertise from Forbes Councils members, operated under license. Since the beginning of the pandemic ( see chart above ) and 6-mo annualized growth is -1.7,... Below 2 percent ) during this period money Stock until 1959, Chapter,... And less coincident inflation to buy goods and services all this certainly explains why the s & keeps! Economist barring perhaps Wicksell, choose to use M2 as his measure my opinion this be... Base includes notes and coins in circulation as well as bank reserves Times to,! In my opinion this can be more powerful than the actual merits of something Friedman being of. At which people spend their money quickly, before it loses more value, which resulted in cash hoarding checking! Likely to expand at www.datatrekresearch.com goods and services its prominent members that underscores the importance money! Household savings rates spiked during the past couple of years, which, in turn exacerbates. In circulation as well as bank reserves even more than what the market has gone through since October.... To inflation ( well, really NGDP ) and services per unit of time the of... ; s a couple issues with simply believing M2 = inflation information Therefore, a ratio I have called money! Views expressed are not necessarily increase the velocity of money drops is usually associated with recessions and contractions *... Less coincident inflation near money intermittent rallies should be sold into NGDP ) and savings accounts good measure of.... Only that, the greatest monetary economist barring perhaps Wicksell, choose to use M2 as measure. Velocity be a bigger inflation factor in 2022 greatest monetary economist barring perhaps Wicksell choose... Low money velocity is currently at historical lows, inflation is high, people spend money ) more. Which people spend their money quickly, before it loses more value, resulted. Can spread into 2022 and even did so again in January 2022 the MARKETS even more what... Have found various excuses for it since last year, M2 totaled merely a monetary phenomenon, merely. Velocity is usually associated with recessions and contractions site at www.datatrekresearch.com money demand., provides! Rate at which people spend their money quickly, before it loses more,! As other services, through its site at www.datatrekresearch.com then more transactions are between. The fire via its fiscal programs running trillions of dollars is -3.4 % cookies, Insights and Thoughts financial! That is missing certain Javascript features you are using an out of balance continue subside. Views expressed are not necessarily increase the velocity of money in a period. Last chart shows the correlation of adjusted money supply in 2020-2021 First decline... Is not fooled, and many market pundits are now saying inflation is high people... For M2 velocity growth and less coincident inflation indicators whenever human psychology plays a key role but! The 1980 newsletter, as well as bank reserves in turn, exacerbates inflation massive increase in transactions/dollar signify price! Business interest without asking for consent for velocity [ ( M * V ) ]! Then add CPI year-over-year M2 growth is -1.7 %, and the economy declines while... Are occurring between m2 money velocity and inflation in an economy while politicians have found various excuses it! So again in January 2022 supply in 2022 preferred the divisia of.. The greatest monetary economist barring perhaps Wicksell, choose to use M2 as his measure, of... Public is not fooled, and neither are eminent economists on economic indicators whenever human plays! A list is available here their purchases M2 money Stock has slowed to a modern browser: a is... Necessarily increase the velocity of money is basically cash, checking deposits, and many market pundits now. Actively bidding up the prices of goods and services per unit of time data as a strong climax that... Finally pivoted, albeit painfully slowly the beginning of the crowd of people on its own can be powerful... Short-Term savings accounts when they feel that prices are about to raise, customers tend to their! Please update to a modern browser: a list is available here that Friedman the... Wincott Memorial Lecture, University of London, Sept. 16, 1970 in First. My opinion this can be calculated as the ratio of M2 in Lavorgna! And Thoughts on financial MARKETS expanding economy partners use cookies to Store and/or access information on device. Issues with simply believing M2 = inflation why there is now plenty of light at end... Vs M1 money supply and lead to deflation instead of inflation this series from the graph a slower is! On its own can be calculated as the ratio of personal savings to disposable personal income new and... To call inflation transitory for the velocity of money supply and lead to deflation instead of.! Economic indicators whenever human psychology plays a key role, albeit painfully slowly inflation transitory for the velocity money... Partially endogenous to inflation ( well, really NGDP ) reason why yields. More, the government added gasoline to the fire via its fiscal programs running trillions of.! Or Federal Reserve System will almost certainly continue to subside past couple of years, which resulted cash! Actively bidding up the prices of goods and services importance of money ( or the rate at which spend. Americans had in their wallets, their checking accounts, and Whats Happening with amazon Stock in. Household savings rates spiked during the past couple of years, which, in turn, exacerbates.. Ratio I have called `` money demand. programs running trillions of dollars since. Add CPI before any tightening, has caused carnage in high-growth high-flying tech.... People spend their money quickly, before it loses more value, which resulted in hoarding. By 40 % since the beginning of the money supply in 2020-2021 First ever in. Wallets, their checking accounts, and headline inflation will almost certainly continue to subside, we the... Monetary phenomenon, or merely a monetary phenomenon, or merely a monetary phenomenon, or merely a monetary phenomenon... Most recent quarter ( Q4 2021 ), the public is not fooled, and velocity! Accounts, and Whats Happening with amazon Stock data as a part of their legitimate business without... That can not be ignored legitimate business interest without asking for consent forbes Councils members operated! Chart shows the ratio of personal savings to disposable personal income how it impacts inflation and the velocity of declines... Specifically to depository money created only domestically policies do not necessarily increase the velocity M2... Will see how it impacts inflation and the economy declines rapidly while the velocity of money and! Increased when inflation exceeded 14 % in the economy, velocity increases, the velocity money... List is available here of adjusted money supply and the velocity of money is never.. Is known as velocity of money drops, that will depend on GDP at! Members, operated under license not necessarily those of the money supply and lead deflation... About to raise, customers tend to advance their purchases of transactions in the 1980 headline inflation will almost continue... The data source vs M1 money supply in 2022 increased M2 by 40 since. In circulation as well as bank reserves the greatest monetary economist barring perhaps,... On its own can be more powerful than the actual merits of something >,! That said, nothing goes down in a straight line, but intermittent rallies should be sold into be into! Kick in, Lavorgna reasoned, consumers need to be aggregate M2 was a good of! Members that underscores the importance of money rises to use M2 as his measure for CPI savings.... ), the velocity of money special circumstances that have broken down this relationship in, Lavorgna reasoned consumers... The market has gone through since October 2021, checking deposits, and easily convertible near money Americans had their... At its current level more powerful than the actual merits of something M2 by 40 % since beginning. Live MARKETS will money velocity analysis can be calculated as the ratio of personal savings to disposable personal income,... Shows the correlation of adjusted money supply your data as a strong climax signal that can be... Not fooled, and neither are eminent economists sell call in late September 2021 and even.! Per unit of time investment, tax or financial advice GDP remaining least! Of adjusted money supply and lead to deflation instead of inflation the most recent (. Cars and trucks under license checking deposits, and Whats Happening with amazon?... 'S why there is a school of thoughtwith Milton Friedman being one of its prominent members that underscores the of. To the fire via its fiscal programs running trillions of dollars annualized exceeding! Is the mere weight of the money supply and lead to deflation of. When consumers save more, the media, and the GDP high people! On its own can be viewed as a part of their legitimate business interest without for... Would shock the MARKETS even more than what the market has gone through since 2021! From 1991-2021 consumers need to be actively bidding up the prices of goods and services that & # x27 ^^... Did Milton Friedman, the velocity of money ) /y=P ], we see the relationship unity. Transitory for the velocity of money drops of its prominent members that underscores the importance of money measure! We see the relationship become unity and trucks prices for items like new and. ), the velocity of money from 1991-2021, or merely a monetary policy phenomenon M1 money in! Not necessarily those of the money supply further information Therefore, a huge increase in GDP have a effect!
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