To view the purposes they believe they have legitimate interest for, or to object to this data processing use the vendor list link below. Learn more about the Econ Lowdown Teacher Portal and watch a tutorial on how to use our online learning resources. You may opt-out by. He was a member of Western's Investment Strategy Committee, was responsible for developing the firm's domestic and international outlook, and provided consultation and advice on investment and asset allocation strategies to CFOs, Treasurers, and pension fund managers. As we progress through this post, you will see how it impacts inflation and the GDP. , published 1969. The velocity of money refers to the number of times consumers spend each dollar in a year. Reuters Summary Major U.S. indexes rise; FANGs, transports, chips outperform Cons disc leads S&P sector gainers; real. This could effectively pump the breaks on continued U.S. economic expansion and may even become a stronger headwind. Last week CNBC had some talk about 2022 likely to have the first ever decline in the M2 Money Supply. Source: Do we simply have special circumstances that have broken down this relationship? Thats one reason why 10-year yields have stalled out a slow recovery means slower M2 velocity growth and less coincident inflation. An increase in time deposits destroys money velocity. A higher MV figure means a dollar is cycling through domestic transactions for goods and services more frequently. Maria Arias is a FRED Data Engineer at the St. Louis Fed. Consider M1, the narrowest component. A negative GDP print for Q2 2022 would mean that the U.S. is officially in a recession. Federal Reserve Bank of St. Louis; It is all hindsight. Money velocity (MV) isnt a complicated concept. Referencing data on MV from the Federal Reserve Bank of St. Louis, you can see something noteworthy. 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. 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. Since the GFC, and because of record low interest rates, investors allocated monies toward various asset classes, primarily corporate stock shares and real estate. Essentially, this means that one USD cycled through the U.S. economy in Q4 2021 about. No. 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. His research interests include macroeconomics and the Chinese economy. As a reminder, M2 money is basically cash, checking and retail money market balances and velocity is GDP divided by M2. When the velocity of money declines, it can even offset an increase in money supply and lead to deflation instead of inflation. In the most recent quarter (Q4 2021), the velocity of M2 money stock has slowed to a stunning 1.123. While that is declining, there is a long way to go to return to levels more in line with GDP. 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. Inflation is typically described as a persistent increase in the general price level, such as in the consumer price index. Put another way, the U.S. economy is nothing but a zombie addicted to the Feds ever-growing largesse. 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. Money, no matter how much may be in the system, doesnt translate into inflation if it just sits in the bank collecting dust. And why then would people suddenly decide to hoard money instead of spend it? 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. We know ecommerce did a step-function increase in popularity during the Pandemic Recession. When inflation is high, people spend their money quickly, before it loses more value, which, in turn, exacerbates inflation. View more of Maria's work. Theres a couple issues with simply believing M2 = inflation. Is inflation always and everywhere a monetary phenomenon, or merely a monetary policy phenomenon? Instead of spending new money injected into the economic system over the past 13 years, consumers and businesses have been either hoarding, investing or paying down debt. Chart #5 shows the ratio of M2 to nominal GDP, a ratio I have called "money demand." The left part of the chart, from 1965 1981, clearly shows that rising inflation (red line) came with higher M2 velocity (blue line). The Fed increased M2 by 40% since the beginning of the pandemic (see chart above). m2 '' ^^ m2 . 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. As Milton Friedman might have described it, the government minted $6 trillion out of thin air and dropped it from helicopters all over the country. Our friend Art Cashin recommended we look at US velocity of money as part of our increasingly regular analysis of potential future inflation. 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). Conversely, lower inflation expectations lead to delayed purchases and lower velocity of money, which in turn translates into muted inflation. 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. A small number in the context of $21,728 billion of M2, but still the first reduction in two years. This behavior, which also reflects a decrease in inflation, suggests that confidence in the recovery is still low. 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. Views expressed are not necessarily those of the St. Louis Fed or Federal Reserve System. These put persistent pressure on prices. That allows markets to feel more certain about corporate earnings leverage and growth while also enjoying the valuation benefits of lower rates. The chart above plots the yearly M2 Growth Rate and the Inflation Rate, which is defined as the yearly change in the Consumer Price Index (CPI). Velocity is a ratio of nominal GDP to a measure of the money supply (M1 or M2). The "M2 Money Supply", also referred to as "M2 Money Stock", is a measure for the amount of currency in circulation. issn: 00028282.http://www.jstor.org/stable/1805778. This is clear as GDP since 1999 has been languishing and people have been saving like crazy. 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. I have an alternative to all the "deflation" vs "inflation" debates - an environment that will be stable with just modest inflation . If inflation expectations are high, consumers help materialize those expectations by advancing their purchases while boosting the aggregate demand. https://www.econlib.org/archives/2015/10/everythings_end.html. Oct 25, 2020. Amazon Return To Office Mandate, And Whats Happening With Amazon Stock? Friedman, Milton. I can think of two reasons. He specialized in analysis of Federal Reserve policy and interest rate forecasting, and spearheaded the firm's research into Treasury Inflation Protected Securities (TIPS). High money velocity is usually associated with a healthy, expanding economy. The concept of climax is used to determine the end of market cycles. Time-series GDP deflator and money velocity, from Friedman's 2004 article, "The Fed's Thermostat." It isn't clear if velocity is a measure of GDP/M2 or GNP/M2, but anyway GDP should in general be transacted in US dollars. You are using an out of date browser that is missing certain Javascript features. Friedman, Milton. Within the broad range of available tools for technical analysis, there is a pattern that, in my opinion, fits perfectly with the chart of money velocity shown below. 5 (1980): 10051014. Further Information The Fed has seriously distorted money supply. When the velocity of money declines, it can even offset an increase in money supply and lead to deflation instead of inflation. They help increase inflation of financial assets but not higher consumer prices. Explore resources provided by the Research Division at the Federal Reserve Bank of St. Louis. However, that will depend on GDP remaining at least at its current level. Why didnt an increase in transactions/dollar signify rising price pressure? March 1, 2023. Quarterly. Most surprising of all: how in the world could the Fed not see it? 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. 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. Manage Settings There's a couple issues with simply believing M2 = inflation. The lower-inflation wheels have been set in motion. It's a psychological, self-reinforcing process. Chart #2 shows the 6-mo. M2 Money Stock is a slightly broader measurement of money supply. Investors have long been confounded by the absence of inflation in the U.S. since low interest rates and M2 growth should lead to higher price levels all else equal. Meanwhile, Prof. Hanke predicated in July 2021, based on growth in M2, that the inflation at the end of 2021 would be at least 6% and possibly as high as 9%. The velocity of money (aka, velocity of M2 money stock or simply, money velocity) is one such metric. Bitcoin Donations: bc1qvu8a9uy5p6lptdm3n3hyljer4s9ud2kfm4gv95. 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. You should consult with a licensed professional for advice concerning your specific situation. Powell went on to call inflation transitory for the majority of last year. The second is that Friedman preferred the divisia of M2. 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. . The velocity of money refers to the number of times consumers spend each dollar in a year. 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. 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. The standard formula of Monetarism predicts the former. Please. 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. Money velocity rate has been falling for about twelve years before collapsing in April 2020. 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. Afterall, the formula for MV is simple: GDP/money supply. The Counter-Revolution in Monetary Theory, Wincott Memorial Lecture, University of London, Sept. 16, 1970. It spiked in March 2020 and has remained at high levels since then. During the first and second quarters of 2014, the velocity of the monetary base2 was at 4.4, its slowest pace on record. M1 is the money supply of currency in circulation (notes and coins, traveler's checks [non-bank issuers], demand deposits, and checkable deposits). The opposite is also true: Money velocity decreases when fewer transactions are being made; therefore the economy is likely to shrink. So far, so good. Thousands of investors and financial journalists rely on Nick and Jessicas newsletter every day for their thought-provoking work on markets, data and disruption. The M2 was $21.42 trillion in October 2022, as reported on Nov. 22, 2022. M2 contained non-M1 components which are contractionary. As a reminder, M2 money is basically cash, checking and retail money market balances and "velocity" is GDP divided by M2. While M2 velocity is currently at historical lows, inflation is clearly not high. Chart #1 is the main attraction. For more information on the H.6 release changes and the regulatory amendment that led to the creation of the other liquid deposits component and its inclusion in the M1 monetary aggregate, see the H.6 announcements and Technical Q&As posted on December 17, 2020. 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. issn: 00028282. MacMillan and Company Limited. Not only that, the government added gasoline to the fire via its fiscal programs running trillions of dollars. The Quantity Theory of Money A Restatement. In The Optimum Quantity of Money and Other Essays, published 1969. All rights reserved. The Fed doesn't need to do more than they already have. As we saw above, this is the case of the money velocity. 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 is a change of 2.94% from last quarter and 7.36% from one year ago. M2 consists of M1 plus: (1) small-denomination time deposits (time deposits in amounts of less than $100,000); and (2) balances in retail Money Market Funds. See why for yourself by starting a 2-week FREE trial below. 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. Charts powered by Highcharts. Put it simply, every time you spend a dollar bill someone else receives it. 1). 1956. Ratio, Quarterly, Seasonally Adjusted Q1 1959 to Q4 2022 (5 days . 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. Low money velocity is usually associated with recessions and contractions. It is still mind-boggling to me that the unprecedented growth of M2 has almost completely escaped the public's notice. One logical answer is the rising level Chinese imports during this period. That is the mere weight of the crowd of people on its own can be more powerful than the actual merits of something. After falling for more than a decade, the money velocity chart shows a potential climax pattern. 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. Money growth has eased somewhat in 2021 but continues to run at rates well above 10 percent per year. Last week CNBC had some talk about 2022 likely to have the first ever decline in the M2 Money Supply. The close relationship between inflation and velocity of money is typically driven by consumer psychology. Yesterday the Fed released the all-important (but almost completely ignored) M2 money supply statistics for January '23, and they were good. The personal saving rate can be calculated as the ratio of personal savings to disposable personal income. 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). This gives you the first graph. The velocity of MZM helps determine how often financial assets are switching hands within the economy. Finally, the grocery storekeeper deposits the money into a bank account, and doesn't touch it for the rest of the year. One, M2 is partially endogenous to inflation (well, really NGDP). Let us look at the data: Eyeballing the graph, we see no clear relationship between these variables. Predicting the bottom at this time would be foolhardy. 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.