Case 3 . The M2 for April 2022 is lower by $81.2 billion. 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. 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, and it's great news that it's fading away. Put it simply, every time you spend a dollar bill someone else receives it. 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. Lucas Jr, Robert E. Two Illustrations of the Quantity Theory of Money. The American Economic Review 70, no. M2 increase of 20% to GDP followed by 3 years of 5% inflation. Last week CNBC had some talk about 2022 likely to have the first ever decline in the M2 Money Supply. Velocity of M2 Money Stock . Not anymore. Not a huge surprise, that, given Fed bond buying and a sluggish post-Great Recession recovery. 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. . Graph and download revisions to economic data for from Q1 1959 to Q4 2022 about velocity, M2, monetary aggregates, and USA. Releases from Federal Reserve Bank of St. Louis, More A slower recovery is also a more long-lived recovery, one that can spread into 2022 and even 2023. 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. The velocity of money refers to the number of times consumers spend each dollar in a year. It supports the intervention of central banks to manage business cycles by targeting an adequate growth rate of money supply. Two, velocity plays a large factor in the relationship: M2 Velocity is a . Typically, increasing money velocity leads to higher inflation. What is the M1 money supply? 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. 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 second is that Friedman preferred the divisia of M2. Why, then, has inflation remained persistently low (below 2 percent) during this period? Youll notice the greater correlation and then decoupling. The relationship between money supply and velocity has significant implications for security markets going forward, particularly as it relates to inflation. 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. 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. Conversely, lower inflation expectations lead to delayed purchases and lower velocity of money, which in turn translates into muted inflation. money supply * velocity = nominal GDP. Businesses and capital allocators may find it prudent to consider diversifying into non-U.S. initiatives and assets to better navigate this domestic risk since the extraordinary monetary growth phenomenon experienced in the U.S. has been less pronounced in most other developed economies. M1 is the money supply of currency in circulation (notes and coins, traveler's checks [non-bank issuers], demand deposits, and checkable deposits). My R^2 was 0.754. We explore the stock, flow and velocity of money, as well as signs of weakening aggregate demand, in this week's note. annualized growth rate of M2, which is now -3.4%, down sharply from a high of over 40% in August of 2020. The right side of the equation represents the Gross Domestic product. 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. One would say, who could have seen this? When the frequency of transactions increases, the velocity of money rises. 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. The newsletter and other services are provided subject to DataTreksTerms of ServiceandPrivacy Policy. Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors. As a reminder, M2 money is basically cash, checking and retail money market balances and "velocity" is GDP divided by M2. A decreasing velocity of M1 might indicate fewer short- term consumption transactions are taking place. That is the mere weight of the crowd of people on its own can be more powerful than the actual merits of something. 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. Sign up or read more information atwww.datatrekresearch.com. Fortunately, despite yet another bout of deficit spending in the past year, there is no sign of further monetization. How could that not have resulted in higher prices? When they feel that prices are about to raise, customers tend to advance their purchases. Then, why velocity of money may not mean anything for inflation after all. During the first and second quarters of 2014, the velocity of the monetary base2 was at 4.4, its slowest pace on record. Now surprisingly, MV is 34.4% lower than where it was at coming out of the GFC. Please let me know if this happens regularly @silvan_frank. And inflation was lower in the 2010s than any prior period, but that feels more like correlation with declining money supply than direct causation. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. 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. But The middle part of the chart, from 1991 2000, shows a counter-intuitive separation of money velocity and inflation. Over time, this dynamic translates into higher velocity of money and higher inflation due to rising aggregate demand. Is there such a relationship in the first place? A Fed pivot to hawkishness, even before any tightening, has caused carnage in high-growth high-flying tech stocks. Further Information Skip to main content. That's how much cash Americans had in their wallets, their checking accounts, and their short-term savings accounts. 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. When it goes up, M2 will. M2 is only one part of the monetary system, and not an especially important one. Household savings rates spiked during the past couple of years, which resulted in cash hoarding in checking and savings accounts. Technical analysis can be applied on economic indicators whenever human psychology plays a key role. This is a change of 2.94% from last quarter and 7.36% from one year ago. Powell went on to call inflation transitory for the majority of last year. Sumner, Scott. This indicates the . Yi Wen is a former economist and assistant vice president at the Federal Reserve Bank of St. Louis. Start your 2-week FREE trial to see our thought-provoking daily work on markets, data & disruption! Its possible that a declining MV could have been directly attributed to record low interest rates, which resulted from record high growth of money supply. This can not be undone. That is what happened in the 1990s. Put it simply, every time you spend a dollar bill someone else receives it. R = -0.63 R^2 = 0.40. Thousands of investors and financial journalists rely on Nick and Jessicas newsletter every day for their thought-provoking work on markets, data and disruption. Please enter your email address or username below. 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. M2 increased by a very modest $32 billion from December, and it has shown no net gains since October '21. 5 (1980): 10051014. In other words, MZM money is M2 money minus time deposits. 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. Essentially, this means that one USD cycled through the U.S. economy in Q4 2021 about. Is velocity and inflation correlated? It spiked in March 2020 and has remained at high levels since then. Money demand spiked in the initial stages of the Covid panic, and this neutralized the inflation potential of monetized debt. We see 3 things going on here: The monetary base includes notes and coins in circulation as well as bank reserves. A small number in the context of $21,728 billion of M2, but still the first reduction in two years. All rights reserved. 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. Sumner, Scott. 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. 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. 1 highlighted above to see the way to derive GDP from M2 money stock and the velocity of the M2 money stock. So why did the monetary base increase not cause a proportionate increase in either the general price level or GDP? You should consult with a licensed professional for advice concerning your specific situation. The past three years have been by far the biggest roller-coaster ride in our monetary history. Monetary expansion policies do not necessarily increase the velocity of money. U.S. corporations are now sitting atop the highest corporate debt mountain in U.S. history. 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. Please review the copyright information in the series notes before sharing. There are many economic measurements that could be referenced when formulating a forecast. Conversely, a lower figure would mean the exact opposite, which could indicate a slowing economic backdrop. 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. 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. Two, velocity plays a large factor in the relationship: . Ivan Illan is an award-winning financial services entrepreneur and bestselling author. The velocity of money is a measurement of the rate at which money is exchanged in an economy. 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