In the U.S., the Feds dual mandate is to balance unemployment and inflation. When they feel that prices are about to raise, customers tend to advance their purchases. Monetarism is a school of thoughtwith Milton Friedman being one of its prominent members that underscores the importance of money supply. Everything's Endogenous., Barnett, William A. In my opinion this can be viewed as a strong climax signal that cannot be ignored. 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). Consider M1, the narrowest component. This behavior, which also reflects a decrease in inflation, suggests that confidence in the recovery is still low. Maybe there is a technical problem with the data source. Low money velocity is usually associated with recessions and contractions. Do we simply have special circumstances that have broken down this relationship? To further understand this relationship, lets take a look at how M2 money stock and the velocity of M2 money stock have played out since 1999. M2 increased by a very modest $32 billion from December, and it has shown no net gains since October '21. Federal Reserve Bank of St. Louis, Check the axis on the right for velocity and select Percent Change from Year Ago for CPI. Friedman, Milton. Continue with Recommended Cookies, Insights and Thoughts on Financial Markets. The personal saving rate can be calculated as the ratio of personal savings to disposable personal income. 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. Are you sure you want to remove this series from the graph? 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. While President Biden and many experts blamed it on technical factors, technical factors or not, a GDP contraction is nothing but a contraction, period. Back then, it was Chinese imports. By the end of that year, M2 totaled . issn: 00028282.http://www.jstor.org/stable/1805778. 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. This gives you the first graph. m2 '' ^^ m2 . The Quantity Theory of Money A Restatement. In. Please, Is inflation always and everywhere a monetary phenomenon, or merely a, phenomenon? Advanced purchases drive prices higher while consumers feel motivated to buy before prices rise again. 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. All rights reserved. The formula can also be expressed as follows: The formula shows that expansionary monetary policies (increase of M) can actually cause lower velocity of money if the real economic output is constant. V stands for the velocity of money (or the rate at which people spend money). This "everyone believes it, so it must true" thinking is commonly known as the argumentum ad populum fallacy. Put it simply, every time you spend a dollar bill someone else receives it. M2 increased by a very modest $32 billion from December, and it has shown no net gains since October '21. 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. Please let me know if this happens regularly @silvan_frank. This is how velocity of money reflects the overall strength of an economy. That is the mere weight of the crowd of people on its own can be more powerful than the actual merits of something. Manage Settings One is that M2 can be a good indicator. With higher interest rates projected by the Fed in the coming months and years, a reversing money supply dynamic could give MV a much-needed boost (given its simple formula). Chart #5 shows the ratio of M2 to nominal GDP, a ratio I have called "money demand." Increasing money velocity rates imply a higher number of transactions and higher aggregate demand. Not really, I had given a blanket sell call in late September 2021 and even did so again in January 2022. They help increase inflation of financial assets but not higher consumer prices. 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. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. Sumner, Scott. M2 Velocity. 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. An increase in time deposits destroys money velocity. There is a better alternative than line graphs to eyeball correlations, though: scatter plots. Inflation pressures peaked almost a year ago, and headline inflation will almost certainly continue to subside. Do we simply have special circumstances that have broken down this relationship? A key indicator to track velocity of money is the personal saving rate. One of the most important theories to explain inflation is the monetarist view that, according to Milton Friedman, Inflation is always and everywhere a monetary phenomenon.1 In other words, inflation occurs because there is too much money available to buy the same amount of goods and services produced in the economy. 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. Chart #1 is the main attraction. As velocity dropped through the 1980s, so did inflation. What is the M2 money supply? 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. 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. Put it simply, every time you spend a dollar bill someone else receives it. The Federal Reserve might describe it as the turnover rate of a dollar through the U.S. economy. M2 increase of 20% to GDP followed by 5 years of 5% inflation. 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. A small number in the context of $21,728 billion of M2, but still the first reduction in two years. To ease credit during the pandemic, the central bank helped . M2's huge growth . The charts below illustrate this point. The Quantity Theory of Money A Restatement. In The Optimum Quantity of Money and Other Essays, published 1969. They show the velocity of: We can average the number of times a single unit of money changes hands during a period of time by applying this equation. Why even bother with it? His research interests include macroeconomics and the Chinese economy. 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. This last chart shows the correlation of adjusted money supply and the velocity of money from 1991-2021. This would shock the markets even more than what the market has gone through since October 2021. So, who would you believe? Second, rate of change matters a lot. 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 . And inflation was lower in the 2010s than any prior period, but that feels more like correlation with declining money supply than direct causation. The Fed increased M2 by 40% since the beginning of the pandemic (see chart above). M2*V=P*Y. The velocity of money can be calculated as the ratio of nominal gross domestic product (GDP) to the money supply (V=PQ/M), which can be used to gauge the economys strength or peoples willingness to spend money. One Federal Reserve Bank Plaza, 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. Which is precisely what inflation is. 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. 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? Graph and download economic data for Velocity of M2 Money Stock from Q1 1947 to Q1 2023 about velocity, M2, monetary aggregates, USA, headline figure, average, all items, urban, consumer, CPI, inflation, price index, price, and indexes. LIVE MARKETS Will money velocity be a bigger inflation factor in 2022? R = -0.63 R^2 = 0.40. Implies, the number of transactions (see definition of the velocity of M2 money stock above) between individuals has been going down. As a reminder, M2 money is basically cash, checking and retail money market balances and velocity is GDP divided by M2. 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. If not cycling through transactions, where did all that newly minted money go? Categories; My Account; Sources; Releases; API; Help; St. Louis Fed Home; . Barnett, William A. Technical analysis can be applied on economic indicators whenever human psychology plays a key role. Explore resources provided by the Research Division at the Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, Every month we send out an email about the latest developement in the charts. and in the process is giving huge amounts of free money to financial institutions. Explore resources provided by the Research Division at the Federal Reserve Bank of St. Louis. 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. Essentially, this means that one USD cycled through the U.S. economy in Q4 2021 about. Since the GFC, and because of record low interest rates, investors allocated monies toward various asset classes, primarily corporate stock shares and real estate. Friedman and Divisia Monetary Measures. In. A declining M2 constitutes deflation. Federal Reserve Bank of St. Louis, Units: Friedman and Divisia Monetary Measures. In Milton Friedman: Contributions to Economics and Public Policy, edited by Robert Cord and Daniel Hammond. 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. Historically, M2 has grown along with the economy (see in the chart below). 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. 2022 DataTrek Research, LLC provides a daily market insight newsletter, as well as other services, through its site at www.datatrekresearch.com. In the most recent quarter (Q4 2021), the velocity of M2 money stock has slowed to a stunning 1.123. There's a couple issues with simply believing M2 = inflation. Ratio,Seasonally Adjusted, Frequency: M2 is a measure of the money supply that includes cash, checking deposits, and easily convertible near money. Releases from Federal Reserve Bank of St. Louis, More Why? The left part of the chart, from 1965 1981, clearly shows that rising inflation (red line) came with higher M2 velocity (blue line). Oxford University Press. The former goes to new highs of 2.2x, but the latter remains contained. High money velocity is usually associated with a healthy, expanding economy. The velocity of MZM helps determine how often financial assets are switching hands within the economy. The answer lies in the private sectors dramatic increase in their willingness to hoard money instead of spend it. St. Louis, MO 63102, More The standard formula of Monetarism predicts the former. 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. 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. 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. Of people on its own can be calculated as the turnover rate of a dollar the... 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