A slower recovery is also a more long-lived recovery, one that can spread into 2022 and even 2023. This blog offers commentary, analysis and data from our economists and experts. Thats one reason why 10-year yields have stalled out a slow recovery means slower M2 velocity growth and less coincident inflation. It has caused much public and political outrage. Is velocity and inflation correlated? If you have an ad-blocker enabled you may be blocked from proceeding. Further Information Money velocity (MV) isnt a complicated concept. Do I qualify? The information provided here is not investment, tax or financial advice. https://fred.stlouisfed.org/series/M2V, Now surprisingly, MV is 34.4% lower than where it was at coming out of the GFC. Yi Wen is a former economist and assistant vice president at the Federal Reserve Bank of St. Louis. Federal Reserve Bank of St. Louis Monetary Trends. Why, then, has inflation remained persistently low (below 2 percent) during this period? Explore resources provided by the Research Division at the Federal Reserve Bank of St. Louis. Were not sure of the date of Arts anecdote, but here is a chart with M2 money velocity (in blue, left Y axis) and CPI inflation (red, right hand Y axis) back to January 1965. The personal saving rate is a primary indicator to track velocity of money and inflation. Thousands of investors and financial journalists rely on Nick and Jessicas newsletter every day for their thought-provoking work on markets, data and disruption. By the end of that year, M2 totaled . Two, velocity plays a large factor in the relationship: issn: 00028282. Then they can buy something else with it. But the actual velocity has gone down by 5.85 points, 69 times larger than predicted. When it goes up, M2 will. The consent submitted will only be used for data processing originating from this website. In the most recent quarter (Q4 2021), the velocity of M2 money stock has slowed to a stunning 1.123. 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. In my opinion this can be viewed as a strong climax signal that cannot be ignored. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. Videos showing how the St. Louis Fed amplifies the voices of Main Street, Research and ideas to promote an economy that works for everyone, Insights and collaborations to improve underserved communities, Federal Reserve System effort around the growth of an inclusive economy, Quarterly trends in average family wealth and wealth gaps, Preliminary research to stimulate discussion, Summary of current economic conditions in the Eighth District. Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors. Then, why velocity of money may not mean anything for inflation after all. Oxford University Press. 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). Amazon Return To Office Mandate, And Whats Happening With Amazon Stock? If not cycling through transactions, where did all that newly minted money go? V stands for the velocity of money (or the rate at which people spend money). My R^2 was 0.754. m2 '' ^^ m2 . This site requires JavaScript to run correctly. Friedman, Milton. Retirement account balances and time deposits above $100,000 are omitted from M2. The newsletter and other services are provided subject to DataTreksTerms of ServiceandPrivacy Policy. Data in this graph are copyrighted. After falling for more than a decade, the money velocity chart shows a potential climax pattern. Expertise from Forbes Councils members, operated under license. It is all hindsight. LIVE MARKETS Will money velocity be a bigger inflation factor in 2022? Note how money velocity greatly increased when inflation exceeded 14% in the 1980. The M2 money supply exploded from $15.5 trillion in February '20 to $21.5 trillion in January '22. A nice clean relationship. Conversely, a lower figure would mean the exact opposite, which could indicate a slowing economic backdrop. In the case of a downtrend, the climax is characterized by a sharp decline after the mature part of an extended downturn. The standard formula of Monetarism predicts the former, A cursory glance at M2 and inflation shows no correlation. Why was there only a handful of economists who commented on it, as I noted a year ago? Report. Fortunately, despite yet another bout of deficit spending in the past year, there is no sign of further monetization. Then the owner of the store spends it to buy groceries. ). Then they can buy something else with it. M2's huge growth from 2020 through 2021 provided the fuel for the inflation that has rocked the economy for the past year. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. Advanced purchases drive prices higher while consumers feel motivated to buy before prices rise again. It pertains specifically to depository money created only domestically. issn: 00028282.http://www.jstor.org/stable/1805778. As human beings and social creatures . Year-over-year M2 growth is -1.7%, and 6-mo annualized growth is -3.4%. MacMillan and Company Limited. 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. No. M2 increase of 20% to GDP followed by 5 years of 5% inflation. As velocity dropped through the 1980s, so did inflation. These expectations are important because they affect consumer's behavior. Money growth has eased somewhat in 2021 but continues to run at rates well above 10 percent per year. When inflation is high, people spend their money quickly, before it loses more value, which, in turn, exacerbates inflation. So, who would you believe? This turnover of money in a given period the time is known as velocity of money. Related Categories . That is what happened in the 1990s. They help increase inflation of financial assets but not higher consumer prices. 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. It's a psychological, self-reinforcing process. There's a couple issues with simply believing M2 = inflation. In any event, here we are; the flood of funny money is receding. 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. A decreasing velocity of M1 might indicate fewer short- term consumption transactions are taking place. Please disable your ad-blocker and refresh. It used to be aggregate M2 was a good measure of this. A Technical Approach. How this graph was created: Search FRED for "M2 Money Velocity" and choose the series "Velocity of M2 Money Stock", or M2V. According to Bannister and Forward (2002, page 28), Money supply growth and inflation are inexorably linked. M2 Money Stock is a slightly broader measurement of money supply. So, if everyone believes it, so it must be true. This dynamic can have a huge impact on inflation. Since 10-year interest rates declined by about 0.5 percentage points between 2008 and 2013, the velocity of the monetary base should have decreased by about 0.085 points. Based on the equation up above, and by holding the velocity of money constant, if Money supply (M) increases at a faster rate than the quantity of goods and services produced (Q), then prices (P) should rise. Velocity of M2 Money Stock [M2V], 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. 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 economy's strength or people's willingness to spend money. m2 6 r^2 = 0.0259. Friedman and Divisia Monetary Measures. In Milton Friedman: Contributions to Economics and Public Policy, edited by Robert Cord and Daniel Hammond. 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. We dont yet know if or how that will alter inflation trends. Market Implications Q stands for the quantity of goods and services produced. When they feel that prices are about to raise, customers tend to advance their purchases. The linked post was written on February 3, 2022, and unsurprisingly, the U.S. printed a negative 1.4% GDP read. 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. Source: 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. The charts below illustrate this point. 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. Velocity is a ratio of nominal GDP to a measure of the money supply (M1 or M2). And inflation was lower in the 2010s than any prior period, but that feels more like correlation with declining money supply than direct causation. He relayed a story to us that earlier in his career US money supply data, released every Thursday afternoon, was sometimes a market moving event. 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. Is that really a big deal given 2020 record 25% growth followed by 2021 12% growth? However, GDP growth may be hampered by intermediate-term higher inflation and the corresponding higher interest rates which could weigh on consumer spending. 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. 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. In other words, MZM money is M2 money minus time deposits. 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. We and our partners use data for Personalised ads and content, ad and content measurement, audience insights and product development. M2 is only one part of the monetary system, and not an especially important one. When it goes up, M2 will. CRN202504-2146319. Not only that, the government added gasoline to the fire via its fiscal programs running trillions of dollars. 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. 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. Case 3 . 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. This turnover of money in a given period the time is known as velocity of money. Calculated as the ratio of quarterly nominal GDP to the quarterly average of M2 money stock. Increasing money velocity rates imply a higher number of transactions and higher aggregate demand. Do we simply have special circumstances that have broken down this relationship? Lucas Jr, Robert E. Two Illustrations of the Quantity Theory of Money. The American Economic Review 70, no. 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. Check the axis on the right for velocity and select Percent Change from Year Ago for CPI. , edited by Robert Cord and Daniel Hammond. One is that M2 can be a good indicator. money supply * velocity = nominal GDP. What is the M2 money supply? 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. This is a moderately strong relationship. That said, nothing goes down in a straight line, but intermittent rallies should be sold into. All this certainly explains why the S&P keeps making new highs . 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." For this reason, the charts cannot be displayed. Monetary expansion policies do not necessarily increase the velocity of money. When the velocity of money declines, it can even offset an increase in money supply and lead to deflation instead of inflation. To ensure this doesnt happen in the future, please enable Javascript and cookies in your browser. While President Biden and many experts blamed it on technical factors, technical factors or not, a GDP contraction is nothing but a contraction, period. Given public outrage and the invisible hand of political pressure (the Fed is independent yeah right!!! The M2 for April 2022 is lower by $81.2 billion. Federal Reserve Bank of St. Louis, Sign up or read more information atwww.datatrekresearch.com. 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. Bitcoin Donations: bc1qvu8a9uy5p6lptdm3n3hyljer4s9ud2kfm4gv95. 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. 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. 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. Back then, it was Chinese imports. R= -0.98 R^2 = 0.97. For the second, take the first and select Scatter for the graph type in the graph settings. The Fed has seriously distorted money supply. 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. When confidence is restored, we should expect to see a rebound in the velocity of money. 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. 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? 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. Essentially, this means that one USD cycled through the U.S. economy in Q4 2021 about. https://www.econlib.org/archives/2015/10/everythings_end.html. This dynamic can have a significant effect on inflation indexes. High money velocity is usually associated with a healthy, expanding economy. Please, Is inflation always and everywhere a monetary phenomenon, or merely a, phenomenon? Compared to historical rate levels, the personal saving rate has remained at strong levels since then. and in the process is giving huge amounts of free money to financial institutions. 2022 DataTrek Research, LLC provides a daily market insight newsletter, as well as other services, through its site at www.datatrekresearch.com. Explore resources provided by the Research Division at the Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, 2). There is a better alternative than line graphs to eyeball correlations, though: scatter plots. Household savings rates spiked during the past couple of years, which resulted in cash hoarding in checking and savings accounts. View more of Maria's work. 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. Copyright Broken Pie Chart Podcast. Not anymore. 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. Learn more about the Econ Lowdown Teacher Portal and watch a tutorial on how to use our online learning resources. 1956. 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. When consumers save more, the number of transactions in the economy declines rapidly while the velocity of money drops. The money supplyis 100 for t = 0, 1. 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. St. Louis, MO 63102, More I have done a series of posts, covering various economic indicators, on expected recession in 2022 since July 2021. Ratio, Quarterly, Seasonally Adjusted Q1 1959 to Q4 2022 (5 days . Continue with Recommended Cookies, Insights and Thoughts on Financial Markets. Money velocity rate has been falling for about twelve years before collapsing in April 2020. The relationship between money supply and velocity has significant implications for security markets going forward, particularly as it relates to inflation. All rights reserved. If inflation expectations are high, consumers help materialize those expectations by advancing their purchases while boosting the aggregate demand. Afterall, the formula for MV is simple: GDP/money supply. Federal Reserve Bank of St. Louis, Units: 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. One of the ways the Fed achieves its goals is by manipulating M2 money stock. Copyright 2023 Apple Inc. All rights reserved. I have an alternative to all the "deflation" vs "inflation" debates - an environment that will be stable with just modest inflation . ), the Fed has finally pivoted, albeit painfully slowly. Comparing M2 vs M1 money supply Discussing massive increase in money supply in 2020-2021 First ever decline in money supply in 2022? Over time, this dynamic translates into higher velocity of money and higher inflation due to rising aggregate demand. How is velocity of money calculated? I dont see a bottom yet. This chart further suggests that the year-over-year change in the CPI will gradually fall to the Fed's 2% target over the course of this year, thanks to the huge deceleration in M2 growth over the past year. 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). Inflation pressures peaked almost a year ago, and headline inflation will almost certainly continue to subside. 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. Ratio,Seasonally Adjusted, Frequency: When there are more transactions being made throughout the economy, velocity increases, and the economy is likely to expand. GDP = M2 Money Stock * The Velocity of M2 Money Stock - (Eq. 1). 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). Manage Settings Case 2. 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). In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. Maybe there is a technical problem with the data source. What is the M1 money supply? Charts powered by Highcharts. 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). When there are more transactions being made throughout the economy, velocity increases, and the economy is likely to expand. 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 (aka, velocity of M2 money stock or simply, money velocity) is one such metric.
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