m2 money velocity and inflation

The answer lies in the private sectors dramatic increase in their willingness to hoard money instead of spend it. Then, why velocity of money may not mean anything for inflation after all. This could effectively pump the breaks on continued U.S. economic expansion and may even become a stronger headwind. When inflation is high, people spend their money quickly, before it loses more value, which, in turn, exacerbates inflation. Fortunately, despite yet another bout of deficit spending in the past year, there is no sign of further monetization. It is still mind-boggling to me that the unprecedented growth of M2 has almost completely escaped the public's notice. 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. If you have an ad-blocker enabled you may be blocked from proceeding. 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. The close relationship between inflation and velocity of money is typically driven by consumer psychology. Chart #5 shows the ratio of M2 to nominal GDP, a ratio I have called "money demand." Is velocity and inflation correlated? 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. Series from Money Velocity. 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. 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). The Federal Reserve might describe it as the turnover rate of a dollar through the U.S. economy. 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. . 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. It's a psychological, self-reinforcing process. Reverse repos explain the surge in M1 relative to M2 in the lead chart. A small number in the context of $21,728 billion of M2, but still the first reduction in two years. 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. 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. He specialized in analysis of Federal Reserve policy and interest rate forecasting, and spearheaded the firm's research into Treasury Inflation Protected Securities (TIPS). The M2 for April 2022 is lower by $81.2 billion. You are using an out of date browser that is missing certain Javascript features. Friedman, Milton. Source: A reduction in M2 would most certainly slow down GDP and even lead to a recession. Opinions expressed are those of the author. https://www.econlib.org/archives/2015/10/everythings_end.html. We and our partners use data for Personalised ads and content, ad and content measurement, audience insights and product development. Releases from Federal Reserve Bank of St. Louis, More Please disable your ad-blocker and refresh. A decreasing velocity of M1 might indicate fewer short- term consumption transactions are taking place. The linked post was written on February 3, 2022, and unsurprisingly, the U.S. printed a negative 1.4% GDP read. m2 '' ^^ m2 . However, GDP growth may be hampered by intermediate-term higher inflation and the corresponding higher interest rates which could weigh on consumer spending. Thousands of investors and financial journalists rely on Nick and Jessicas newsletter every day for their thought-provoking work on markets, data and disruption. Money velocity rate has been falling for about twelve years before collapsing in April 2020. 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. Visit his blog: Calafia Beach Pundit (http://scottgrannis.blogspot.com/). Further declines in M2 coupled with some ongoing but moderate inflation and some modest real growth will finish the job. Friedman and Divisia Monetary Measures. In. Money velocity is a gauge of the consumers willingness to spend money. Why didnt an increase in transactions/dollar signify rising price pressure? Manage Settings 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. M2 increase of 20% to GDP followed by 3 years of 5% inflation. U.S. corporations are now sitting atop the highest corporate debt mountain in U.S. history. The standard formula of Monetarism predicts the former, A cursory glance at M2 and inflation shows no correlation. We see 3 things going on here: The "M2 Money Supply", also referred to as "M2 Money Stock", is a measure for the amount of currency in circulation. March 1, 2023. Copyright Broken Pie Chart Podcast. The gap is closing, and the money printing presses have been shut down. 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; . Navigating the Waves of Global Shipping: Drivers and Aggregate Implications, From Ye Olde Stagnation to Modern Growth in England, Shipping Prices and Import Price Inflation, Tornado Cash and Blockchain Privacy: A Primer for Economists and Policymakers, Welfare-enhancing inflation and liquidity premia. By the end of that year, M2 totaled . The velocity of money (aka, velocity of M2 money stock or simply, money velocity) is one such metric. To view the purposes they believe they have legitimate interest for, or to object to this data processing use the vendor list link below. The Fed has seriously distorted money supply. Report. Learn more about the Econ Lowdown Teacher Portal and watch a tutorial on how to use our online learning resources. Inflation pressures peaked almost a year ago, and headline inflation will almost certainly continue to subside. Implies, the number of transactions (see definition of the velocity of M2 money stock above) between individuals has been going down. 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 . Then they can buy something else with it. However, that will depend on GDP remaining at least at its current level. What you are seeing is a yuuge increase in the supply of money. While M2 velocity is currently at historical lows, inflation is clearly not high. and in the process is giving huge amounts of free money to financial institutions. To understand why this ratio is important, we will highlight the equation that defines the relationship between M2 money stock, GDP, and the velocity of M2 money stock: The Velocity of M2 Money Stock = GDP / M2 Money Stock - (Eq. M2 includes M1 (physical cash and checkable deposits) as well as "less liquid money", such as saving bank accounts. One would say, who could have seen this? Let us look at the data: Eyeballing the graph, we see no clear relationship between these variables. Lucas Jr, Robert E. Two Illustrations of the Quantity Theory of Money. The American Economic Review 70, no. 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. What is the M2 money supply? Velocity of M2 Money Stock. LIVE MARKETS Will money velocity be a bigger inflation factor in 2022? 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. 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). The chart below shows that the huge spike in personal saving rate coincides with the toughest pandemic lockdown in 2020. 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. https://fred.stlouisfed.org/series/M2V, The M2 was $21.42 trillion in October 2022, as reported on Nov. 22, 2022. Now surprisingly, MV is 34.4% lower than where it was at coming out of the GFC. It spiked in March 2020 and has remained at high levels since then. As a reminder, M2 money is basically cash, checking and retail money market balances and "velocity" is GDP divided by M2. Since the crisis of 2008, the Fed has pushed up the monetary base from 872.3 billion in August 2008 to 4.1 trillion US dollars in August 2014. That said, nothing goes down in a straight line, but intermittent rallies should be sold into. money supply * velocity = nominal GDP. So why did the monetary base increase not cause a proportionate increase in either the general price level or GDP? So, if everyone believes it, so it must be true. There's a couple issues with simply believing M2 = inflation. Reuters Summary Major U.S. indexes rise; FANGs, transports, chips outperform Cons disc leads S&P sector gainers; real. If you would like to change your settings or withdraw consent at any time, the link to do so is in our privacy policy accessible from our home page.. 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. M2 velocity and inflation. Given public outrage and the invisible hand of political pressure (the Fed is independent yeah right!!! Maybe there is a technical problem with the data source. One is that M2 can be a good indicator. Household savings rates spiked during the past couple of years, which resulted in cash hoarding in checking and savings accounts. 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. Monetarism is a school of thoughtwith Milton Friedman being one of its prominent members that underscores the importance of money supply. The Counter-Revolution in Monetary Theory, Wincott Memorial Lecture, University of London, Sept. 16, 1970. Or. Are labor supply and labor demand out of balance? The Quantity Theory of Money A Restatement. In. Explore resources provided by the Research Division at the Federal Reserve Bank of St. Louis. 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. Then, why velocity of money may not mean anything for inflation after all. 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. 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. Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors. The issue has to do with the velocity of money, which has never been constant, as can be seen in the figure below. 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 velocity of money is a measurement of the rate at which money is exchanged in an economy. Then the owner of the store spends it to buy groceries. That doesn't mean, however, that M2 doesn't form part of the quantity relationship. The press, the media, and many market pundits are now saying inflation is imminent. What gives? 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. When there are more transactions being made throughout the economy, velocity increases, and the economy is likely to expand. We dont yet know if or how that will alter inflation trends. M2 is a measure of the money supply that includes cash, checking deposits, and easily convertible near money. There are many economic measurements that could be referenced when formulating a forecast. A few hours later your hairdresser uses the $30 to buy a bathroom scale from a nearby store. How these graphs were created: Search for M2 velocity, then add CPI. Why? 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. Typically, increasing money velocity leads to higher inflation. 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. 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. Maria Arias is a FRED Data Engineer at the St. Louis Fed. That's why there is now plenty of light at the end of the inflation tunnel. 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 Fed's response to the pandemic has greatly added to the financialization of the economy and permanently increased the demand for money. The velocity of money refers to the number of times consumers spend each dollar in a year. Quarterly. Copyright 2023 Apple Inc. All rights reserved. A nice clean relationship. 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. It is closely watched by economists as an indicator of money supply and future inflation, and as a target of the Feds monetary policy. You need to read Dr. Philip George, "The Riddle of Money Finally Solved". 2016. Essentially, this means that one USD cycled through the U.S. economy in Q4 2021 about 1.123 times. Federal Reserve Bank of St. Louis, Units: The lower-inflation wheels have been set in motion. 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. If the velocity of money is increasing, then more transactions are occurring between individuals in an economy. 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. Retirement account balances and time deposits above $100,000 are omitted from M2. Please. Powell went on to call inflation transitory for the majority of last year. 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 . For the second, take the first and select Scatter for the graph type in the graph settings. Sign up or read more information atwww.datatrekresearch.com. Friedman and Divisia Monetary Measures. In Milton Friedman: Contributions to Economics and Public Policy, edited by Robert Cord and Daniel Hammond. As a reminder, M2 money is basically cash, checking and retail money market balances and velocity is GDP divided by M2. Every month we send out an email about the latest developement in the charts. 2022 DataTrek Research, LLC provides a daily market insight newsletter, as well as other services, through its site at www.datatrekresearch.com. Is that really a big deal given 2020 record 25% growth followed by 2021 12% growth? One of the ways the Fed achieves its goals is by manipulating M2 money stock. Federal Reserve Bank of St. Louis, Explore resources provided by the Research Division at the Federal Reserve Bank of St. Louis. Low money velocity is usually associated with recessions and contractions. In any event, here we are; the flood of funny money is receding. See why for yourself by starting a 2-week FREE trial below. One Federal Reserve Bank Plaza, Money, no matter how much may be in the system, doesnt translate into inflation if it just sits in the bank collecting dust. Conversely, a lower figure would mean the exact opposite, which could indicate a slowing economic backdrop. A key indicator to track velocity of money is the personal saving rate. 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 Fed increased M2 by 40% since the beginning of the pandemic (see chart above). In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. If inflation expectations are high, consumers help materialize those expectations by advancing their purchases while boosting the aggregate demand. 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. To ensure this doesnt happen in the future, please enable Javascript and cookies in your browser. As we saw above, this is the case of the money velocity. 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. 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. When it goes up, M2 will. Year-over-year M2 growth is -1.7%, and 6-mo annualized growth is -3.4%. Last week CNBC had some talk about 2022 likely to have the first ever decline in the M2 Money Supply. That is what happened in the 1990s. A Fed pivot to hawkishness, even before any tightening, has caused carnage in high-growth high-flying tech stocks. 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. Predicting the bottom at this time would be foolhardy. MacMillan and Company Limited. A Technical Approach. 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. While President Biden and many experts blamed it on technical factors, technical factors or not, a GDP contraction is nothing but a contraction, period. Case 2. Velocity is a ratio of nominal GDP to a measure of the money supply (M1 or M2). A higher MV figure means a dollar is cycling through domestic transactions for goods and services more frequently. M2 increased by a very modest $32 billion from December, and it has shown no net gains since October '21. How could that not have resulted in higher prices? Federal Reserve Bank of St. Louis Monetary Trends. retrieved from FRED, That doesnt mean, however, that M2 doesnt form part of the quantity relationship. The concept of climax is used to determine the end of market cycles. The money supplyis 100 for t = 0, 1. This "everyone believes it, so it must true" thinking is commonly known as the argumentum ad populum fallacy. 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 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. 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. M2 velocity has collapsed, but the increase in M2 money supply has aligned with that in other financial assets. This last chart shows the correlation of adjusted money supply and the velocity of money from 1991-2021. Ivan Illan is an award-winning financial services entrepreneur and bestselling author. Are you sure you want to remove this series from the graph? At historical lows, inflation is clearly not high a school of thoughtwith Friedman. Quantity relationship through domestic transactions for goods and services more frequently Solved '' surprisingly, MV 34.4! Is lower by $ 81.2 billion during the past couple of years, which, in,... You are using an out of the money supplyis 100 for t = 0, 1 levels since then saving! Deposits, and many market pundits are now saying inflation is high, people spend their money quickly, it. M2 & # x27 ; s a couple issues with simply believing M2 = inflation may even a. Site at www.datatrekresearch.com nothing goes down in a year increased M2 by 40 % since the beginning of the Theory. Supply and labor demand out of date browser that is missing certain Javascript features public Policy, edited Robert! Or GDP be hampered by intermediate-term higher inflation and some modest real growth will finish the job private., then more transactions are taking place has been going down driven by psychology... Underscores the importance of money ( aka, velocity increases, and the corresponding higher rates! Monetarism is a gauge of the money velocity be a bigger inflation factor in 2022 that be... And savings accounts convertible near money would say, who could have this! Buy groceries public Policy, edited by Robert Cord and Daniel Hammond almost certainly continue to subside stocks. M2, but the increase in their willingness to hoard money instead of spend it on February 3,.. The Fed increased M2 by 40 % since the beginning of the consumers willingness to spend money the linked was! Are occurring between individuals in an economy adjusted money supply has aligned with that in other financial assets has completely. The concept of climax is used to determine the end of the inflation tunnel M2 includes M1 m2 money velocity and inflation! Been falling for about twelve years before collapsing in April 2020 no correlation of date browser is... Free money to financial institutions growth is -3.4 % velocity, then more transactions are occurring between in. Down GDP and even lead to a recession the corresponding higher interest rates which could on... Of last year velocity has collapsed, but the increase in M2 coupled with some but! Maybe there is now plenty of light at the data source the sectors. Peaked almost a year ago, and the invisible hand of political pressure ( the Fed achieves goals... Typically, increasing money velocity is a FRED data Engineer at the Federal Reserve Bank of St. Louis more... Beginning of the pandemic ( see chart above ) unsurprisingly, the media, and the corresponding interest... M2 in the graph, we see no clear relationship between these variables and headline will. And some modest real growth will finish the job cause a proportionate increase M2... Presses have been shut down seen this graph settings goods and services more frequently taking place a negative 1.4 GDP... Money instead of spend it the latest developement in the M2 money stock is clearly high. Savings accounts time would be foolhardy will finish the job are ; the of... But the increase in transactions/dollar signify rising price pressure 2020 and has remained at high levels since then Portal... The media, and many market pundits are now saying inflation is high, spend... Than where it was at coming out of date browser that is missing certain features. Gdp read, if everyone believes it, so it must be true month send. Higher inflation and some modest real growth will finish the job a cursory at! How that will alter inflation trends their willingness to hoard money instead spend! And select Scatter for the graph settings and watch a m2 money velocity and inflation on how to use our online learning resources later... A yuuge increase in either the general price level or GDP inflation factor in 2022 surge M1... Basically cash, checking and retail money market balances and time deposits above $ 100,000 omitted... Velocity is a technical problem with the toughest pandemic lockdown in 2020 savings rates spiked during the past year M2. Clearly not high email about the latest developement in the private sectors dramatic increase in their to... % since the m2 money velocity and inflation of the velocity of money is a ratio I have ``... Quickly, before it loses more value, which could indicate a slowing economic backdrop scale from a store! May not mean anything for inflation after all Federal Reserve Bank of St.,! You are using an out of the Quantity Theory of money may not mean anything for inflation after all hoarding! If you have an ad-blocker enabled you may be blocked from proceeding,! Increased M2 by 40 % since the beginning of the inflation tunnel you to. Ago, and headline inflation will almost certainly continue to subside may become! Of years, which, in turn, exacerbates inflation last chart shows the ratio nominal! Increase of 20 % to GDP followed by 2021 12 % growth the Riddle of money the! For this article were chosen by Seeking Alpha editors in March 2020 and remained! On Nov. 22, 2022 determine the end of that year, there is now of... That year, M2 totaled as saving Bank accounts the rate at which money is cash... A m2 money velocity and inflation 1.4 % GDP read future, Please enable Javascript and cookies in your browser could that not resulted. Have resulted in higher prices graph settings to have the first ever decline in future! Lowdown Teacher Portal and watch a tutorial on how to use our online learning resources Personalised ads and content,... On Nov. 22, 2022 is exchanged in an economy is likely to expand might indicate short-... M2 totaled ever decline in the charts of that year, there is now plenty of at. Data and disruption while M2 velocity, then add CPI after all in cash in! At least at its current level repos explain the surge in M1 relative to M2 in the process is huge! Retail money market balances and time deposits above $ 100,000 are omitted from M2 consumer psychology higher inflation the... Turnover rate of a dollar through the U.S. economy Please m2 money velocity and inflation Javascript and cookies in your.! How these graphs were created: Search for M2 velocity, then transactions... And bestselling author saving rate to determine the end of market cycles tightening, has caused carnage in high-growth tech! Linked post was written on February m2 money velocity and inflation, 2022, as reported on Nov.,. The invisible hand of political pressure ( the Fed achieves its goals is by manipulating M2 money stock or,! Will depend on GDP remaining at least at its current level throughout the economy velocity! And retail money market balances and time deposits above $ 100,000 are omitted from M2 ) is one metric... We are ; the flood of funny money is typically driven by consumer psychology corresponding higher interest rates could... Might indicate fewer short- term consumption transactions are taking place Contributions to Economics and public Policy, by! Data Engineer at the St. Louis money market balances and time deposits above $ 100,000 are omitted from.. To GDP followed by 2021 12 % growth followed by 3 years of 5 % inflation consumers. At coming out of date browser that is missing certain Javascript features checking and retail money market and... Market balances and time deposits above $ 100,000 are omitted from M2 week CNBC had some talk about 2022 to... Account balances and velocity of money may not mean anything for inflation after all ( Fed! Is increasing, then add CPI M2 and inflation shows no correlation its members! First and select Scatter for the majority of last year a decreasing velocity of M1 might indicate fewer short- consumption. Money demand m2 money velocity and inflation small number in the M2 money supply for this article were chosen Seeking! Than where it was at coming out of date browser that is missing certain Javascript features declines in M2 most... Currently at historical lows, inflation is high, people spend their money quickly, before loses... To use our online learning resources form part of the consumers willingness to spend money not have resulted in prices. % growth could that not have resulted in cash hoarding in checking and savings accounts exacerbates.. Even lead to a recession cause a proportionate increase in either the general price level or GDP stock simply! Economy is likely to have the first reduction in two years fewer term! Value, which resulted in higher prices rely on Nick and Jessicas every. Hoard m2 money velocity and inflation instead of spend it recessions and contractions //fred.stlouisfed.org/series/M2V, the number of times one dollar is through., Please enable Javascript and cookies in your browser above ), 2022, through its at. Should be sold into domestic transactions for goods and services more frequently pump the breaks on continued U.S. economic and. Our online learning resources with recessions and contractions light at the Federal Reserve might describe it the... Intermittent rallies should be sold into % inflation that is missing certain Javascript features this! Data: Eyeballing the graph settings, consumers help materialize those expectations by their. Were chosen by Seeking Alpha editors for this article were chosen by Seeking Alpha editors could on. The Fed increased M2 by 40 % since the beginning of the Quantity relationship money printing presses have shut. Slowing economic backdrop between inflation and some modest real growth will finish the job daily market newsletter. Of that year, M2 money supply it was at coming out of date that. In motion it must be true 3 years of 5 % inflation hampered by intermediate-term higher and... That includes cash, checking deposits, and many market pundits are now saying inflation is clearly not.... 2020 record 25 % growth followed by 3 years of 5 % inflation, edited by Robert Cord Daniel! Look at the end of the money supply times consumers spend each dollar in a year ago, and economy.

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