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. Why, then, has inflation remained persistently low (below 2 percent) during this period? When inflation is high, people spend their money quickly, before it loses more value, which, in turn, exacerbates inflation. Chart #5 shows the ratio of M2 to nominal GDP, a ratio I have called "money demand." St. Louis, MO 63102, How to include a FRED graph in your blog or web page, Comparing the racial dissimilarity index across counties, Updating the name of the television services series in the CPI, Racial dissimilarity in St Louis, Missouri. To ensure this doesnt happen in the future, please enable Javascript and cookies in your browser. 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. Everything's Endogenous. EconLog. Copyright 2023 Apple Inc. All rights reserved. Learn more about the Econ Lowdown Teacher Portal and watch a tutorial on how to use our online learning resources. The newsletter and other services are provided subject to DataTreksTerms of ServiceandPrivacy Policy. Lucas Jr, Robert E. Two Illustrations of the Quantity Theory of Money. The American Economic Review 70, no. A nice clean relationship. When inflation is high, prices for goods and services rise and thus the purchasing power per unit of currency decreases. Federal Reserve Bank of St. Louis, Units: Federal Reserve Bank of St. Louis; . Lucas Jr, Robert E. Two Illustrations of the Quantity Theory of Money. The American Economic Review 70, no. The left part of the chart, from 1965 1981, clearly shows that rising inflation (red line) came with higher M2 velocity (blue line). 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 . In this case the velocity of money is 3 since three items, or services, have been bought with the same money. Bitcoin Donations: bc1qvu8a9uy5p6lptdm3n3hyljer4s9ud2kfm4gv95. See why for yourself by starting a 2-week FREE trial below. Interactive map of the Federal Open Market Committee, Regular review of community and economic development issues, Podcast about advancing a more inclusive and equitable economy, Interesting graphs using data from our free economic database, Conversations with experts on their research and topics in the news, Podcast featuring economists and others making their marks in the field, Economic history from our digital library, Scholarly research on monetary policy, macroeconomics, and more. Year-over-year M2 growth is -1.7%, and 6-mo annualized growth is -3.4%. As a reminder, M2 money is basically cash, checking and retail money market balances and "velocity" is GDP divided by M2. The first signs of this are now on record. Over time, this dynamic translates into higher velocity of money and higher inflation due to rising aggregate demand. Federal Reserve Bank of St. Louis, So why did the monetary base increase not cause a proportionate increase in either the general price level or GDP? Artificial Intelligence Companies You May Want To Consider, investors allocated monies toward various asset classes. Retirement account balances and time deposits above $100,000 are omitted from M2. 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. I dont see a bottom yet. M2 is only one part of the monetary system, and not an especially important one. Is there such a relationship in the first place? Now, it could be the deflationary impact of consumer activities like online shopping since this offers greater price transparency than single store in-person visits. Last week CNBC had some talk about 2022 likely to have the first ever decline in the M2 Money Supply. Fortunately, despite yet another bout of deficit spending in the past year, there is no sign of further monetization. The Fed doesn't need to do more than they already have. In the most recent quarter (Q4 2021), the velocity of M2 money stock has slowed to a stunning 1.123. Wh 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. Graph and download revisions to economic data for from Q1 1959 to Q4 2022 about velocity, M2, monetary aggregates, and USA. m2 '' ^^ m2 . 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). . We can think of shorter- term transactions as consumption we might make on an everyday basis. 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. The monetary base includes notes and coins in circulation as well as bank reserves. In the U.S., the Feds dual mandate is to balance unemployment and inflation. That is the mere weight of the crowd of people on its own can be more powerful than the actual merits of something. Is this happening to you frequently? M2*V=P*Y. 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. M2 increased by a very modest $32 billion from December, and it has shown no net gains since October '21. You are using an out of date browser that is missing certain Javascript features. Oxford University Press. The personal saving rate is a primary indicator to track velocity of money and inflation. Historically, M2 has grown along with the economy (see in the chart below). If the velocity of money is increasing, then more transactions are occurring between individuals in an economy. Please review the copyright information in the series notes before sharing. What is the M2 money supply? Related Categories . Friedman and Divisia Monetary Measures. In Milton Friedman: Contributions to Economics and Public Policy, edited by Robert Cord and Daniel Hammond. 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. 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. This means that every dollar in the monetary base was spent only 4.4 times in the economy during the past year, down from 17.2 just prior to the recession. An error appeared while loading the data. There are two ways for M2/GDP to decline: 1) slower M2 growth and/or 2) faster nominal GDP growth, which almost certainly entails higher inflation (because nominal GDP has two components:. 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. If the velocity of money is increasing, then more transactions are occurring between individuals in an economy. Every month we send out an email about the latest developement in the charts. When it goes up, M2 will. 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. M2 increased by a very modest $32 billion from December, and it has shown no net gains since October '21. Please update to a modern browser: a list is available here. Youll notice the greater correlation and then decoupling. 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. 2016. This is clear as GDP since 1999 has been languishing and people have been saving like crazy. While M2 velocity is currently at historical lows, inflation is clearly not high. The M2 money supply exploded from $15.5 trillion in February '20 to $21.5 trillion in January '22. This turnover of money in a given period the time is known as velocity of money. 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. Do we simply have special circumstances that have broken down this relationship? Do I qualify? If the banks target aggregated M2 they either target the quantity relationships or inflationary factors that affect M2. It is these latter which had, basically, sunk M2 more than thirty years ago as any sort of useful monetary guide. Please let me know if this happens regularly @silvan_frank. M2 contained non-M1 components which are contractionary. Then, why velocity of money may not mean anything for inflation after all. LIVE MARKETS Will money velocity be a bigger inflation factor in 2022? 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. If not cycling through transactions, where did all that newly minted money go? A slower recovery is also a more long-lived recovery, one that can spread into 2022 and even 2023. 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. A declining M2 constitutes deflation. 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. Low money velocity is usually associated with recessions and contractions. 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). You need to read Dr. Philip George, "The Riddle of Money Finally Solved". Copyright Broken Pie Chart Podcast. 1). Please enter your email address or username below. 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. If inflation expectations are high, consumers help materialize those expectations by advancing their purchases while boosting the aggregate demand. St. Louis, MO 63102, More Visit his blog: Calafia Beach Pundit (http://scottgrannis.blogspot.com/). That allows markets to feel more certain about corporate earnings leverage and growth while also enjoying the valuation benefits of lower rates. 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. Back then, it was Chinese imports. Then the owner of the store spends it to buy groceries. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. This "everyone believes it, so it must true" thinking is commonly known as the argumentum ad populum fallacy. According to data from the People's Bank of China (PBC), since April 2022, China's M2, a measure of money supply, has maintained a double-digit growth rate. How this graph was created: Search FRED for "M2 Money Velocity" and choose the series "Velocity of M2 Money Stock", or M2V. A higher MV figure means a dollar is cycling through domestic transactions for goods and services more frequently. Case 3 . Two, velocity plays a large factor in the relationship: . March 1, 2023. That doesn't mean, however, that M2 doesn't form part of the quantity relationship. Ratio, Quarterly, Seasonally Adjusted Q1 1959 to Q4 2022 (5 days . It spiked in March 2020 and has remained at high levels since then. Velocity of M2 Money Stock. Since the GFC, and because of record low interest rates, investors allocated monies toward various asset classes, primarily corporate stock shares and real estate. Explore resources provided by the Research Division at the Federal Reserve Bank of St. Louis. According to the Quantity Theory of Money, inflation depends on the money supply and its velocity. 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 . CRN202504-2146319. At first this was fine, because the public was not willing or able to spend itthe demand for money was intense. The Counter-Revolution in Monetary Theory, Wincott Memorial Lecture, University of London, Sept. 16, 1970. 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 . Thousands of investors and financial journalists rely on Nick and Jessicas newsletter every day for their thought-provoking work on markets, data and disruption. 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. retrieved from FRED, How these graphs were created: Search for M2 velocity, then add CPI. Further declines in M2 coupled with some ongoing but moderate inflation and some modest real growth will finish the job. 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. Velocity of M2 Money Stock . The personal saving rate can be calculated as the ratio of personal savings to disposable personal income. Technical analysis can be applied on economic indicators whenever human psychology plays a key role. For higher inflation to kick in, Lavorgna reasoned, consumers need to be actively bidding up the prices of goods and services. Youre probably familiar with economic data like unemployment figures, Fed funds rate and the inflation rate. Not really, I had given a blanket sell call in late September 2021 and even did so again in January 2022. 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. 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. I have done a series of posts, covering various economic indicators, on expected recession in 2022 since July 2021. Then they can buy something else with it. That is what happened in the 1990s. 1956. We and our partners use cookies to Store and/or access information on a device. No wholesale; no offshore. m2 6 r^2 = 0.0259. 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. 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. M2 Money Stock is a slightly broader measurement of money supply. When they feel that prices are about to raise, customers tend to advance their purchases. Afterall, the formula for MV is simple: GDP/money supply. 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. Maria Arias is a FRED Data Engineer at the St. Louis Fed. Amazon Return To Office Mandate, And Whats Happening With Amazon Stock?