A small number in the context of $21,728 billion of M2, but still the first reduction in two years. No. A declining M2 constitutes deflation. , edited by Robert Cord and Daniel Hammond. ). 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. Please, Is inflation always and everywhere a monetary phenomenon, or merely a, phenomenon? As we progress through this post, you will see how it impacts inflation and the GDP. 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. Household savings rates spiked during the past couple of years, which resulted in cash hoarding in checking and savings accounts. Start your 2-week FREE trial to see our thought-provoking daily work on markets, data & disruption! Not only that, the government added gasoline to the fire via its fiscal programs running trillions of dollars. 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. Copyright 2023 Apple Inc. All rights reserved. Friedman, Milton. Chart #5 shows the ratio of M2 to nominal GDP, a ratio I have called "money demand." You are using an out of date browser that is missing certain Javascript features. Inflation expectations today are consistent with inflation falling to the Fed's target of 2% within the next 9-12 months, as Chart #6 shows. The velocity of money is a measurement of the rate at which money is exchanged in an economy. A nice clean relationship. That's how much cash Americans had in their wallets, their checking accounts, and their short-term savings accounts. retrieved from FRED, Do we simply have special circumstances that have broken down this relationship? Everything's Endogenous. EconLog. and (2) balances in retail Money Market Funds. Put another way, the U.S. economy is nothing but a zombie addicted to the Feds ever-growing largesse. 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. This blog offers commentary, analysis and data from our economists and experts. According to the Quantity Theory of Money, inflation depends on the money supply and its velocity. Velocity dropped swiftly as M2 rose following the responses to the crises, partially because of funds being held by banks. money supply * velocity = nominal GDP. Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors. Afterall, the formula for MV is simple: GDP/money supply. How these graphs were created: Search for M2 velocity, then add CPI. Federal Reserve Bank of St. Louis; , where output is 150, the money velocity is 1.5. Then they can buy something else with it. Sumner, Scott. Money velocity is a gauge of the consumers willingness to spend money. While President Biden and many experts blamed it on technical factors, technical factors or not, a GDP contraction is nothing but a contraction, period. 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. Are labor supply and labor demand out of balance? M2*V=P*Y. 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. Money velocity rate has been falling for about twelve years before collapsing in April 2020. Is inflation always and everywhere a monetary phenomenon, or merely a monetary policy phenomenon? Retirement account balances and time deposits above $100,000 are omitted from M2. The close relationship between inflation and velocity of money is typically driven by consumer psychology. 1956. Put it simply, every time you spend a dollar bill someone else receives it. Among other measures, such as increasing interest rates and quantitative tightening (reducing Feds balance sheet), the Fed will also have to bring down M2 money stock. Inflation (CPI) in the U.S. is at a four-decade high, coming in at 8.3% year-over-year. The relationship between money supply and velocity has significant implications for security markets going forward, particularly as it relates to inflation. The Fed has seriously distorted money supply. The linked post was written on February 3, 2022, and unsurprisingly, the U.S. printed a negative 1.4% GDP read. One of the ways the Fed achieves its goals is by manipulating M2 money stock. However, that will depend on GDP remaining at least at its current level. When inflation is high, prices for goods and services rise and thus the purchasing power per unit of currency decreases. Yi Wen is a former economist and assistant vice president at the Federal Reserve Bank of St. Louis. There's a couple issues with simply believing M2 = inflation. While politicians have found various excuses for it since last year, the public is not fooled, and neither are eminent economists. A higher MV figure means a dollar is cycling through domestic transactions for goods and services more frequently. https://www.econlib.org/archives/2015/10/everythings_end.html. If not cycling through transactions, where did all that newly minted money go? Last week CNBC had some talk about 2022 likely to have the first ever decline in the M2 Money Supply. 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. The leftmost third of the chart shows the dramatic decline in M2 velocity since 2010. 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). This seems troubling. 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. The Quantity Theory of Money A Restatement. In The Optimum Quantity of Money and Other Essays, published 1969. 2016. 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. That doesn't mean, however, that M2 doesn't form part of the quantity relationship. Maybe there is a technical problem with the data source. Barnett, William A. 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. This indicates that 40% of the decrease in the velocity of money can be explained by the increase in the adjusted money supply. 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. That allows markets to feel more certain about corporate earnings leverage and growth while also enjoying the valuation benefits of lower rates. Please update to a modern browser: a list is available here. This dynamic can have a significant effect on inflation indexes. 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. Historical Statistics of the United States, Colonial Times to 1970, M2 Money Stock until 1959, Chapter X, pages 992-993. In other words, MZM money is M2 money minus time deposits. Such an unprecedented increase in money demand has slowed down the velocity of money, as the figure below shows. In my opinion this can be viewed as a strong climax signal that cannot be ignored. 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. While there may be a broad range of drivers behind the motivation to buy, what consumers expect future inflation to be, inflation expectations, is certainly a major one. 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. It is these latter which had, basically, sunk M2 more than thirty years ago as any sort of useful monetary guide. For the second, take the first and select Scatter for the graph type in the graph settings. What is the M2 money supply? Forbes Finance Council is an invitation-only organization for executives in successful accounting, financial planning and wealth management firms. Chart #2 shows the 6-mo. If the velocity of money is increasing, then more transactions are occurring between individuals in an economy. Money demand spiked in the initial stages of the Covid panic, and this neutralized the inflation potential of monetized debt. 2016. Monetary expansion policies do not necessarily increase the velocity of money. Oxford University Press. 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.. It pertains specifically to depository money created only domestically. Please review the copyright information in the series notes before sharing. Then the owner of the store spends it to buy groceries. Calculated as the ratio of quarterly nominal GDP to the quarterly average of M2 money stock. 1). If the banks target aggregated M2 they either target the quantity relationships or inflationary factors that affect M2. Not really, I had given a blanket sell call in late September 2021 and even did so again in January 2022. 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. 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. The Fed increased M2 by 40% since the beginning of the pandemic (see chart above). The Federal Reserve might describe it as the turnover rate of a dollar through the U.S. economy. 2015. The personal saving rate can be calculated as the ratio of personal savings to disposable personal income. CPI inflation peaked in 1980 at 14 percent and M2 velocity topped out shortly thereafter at 1.9x. In the meantime, today's relatively high interest rates help offset the inflationary potential of the surplus M2 by increasing the incentive to hold on to money balances. Last week CNBC had some talk about 2022 likely to have the first ever decline in the M2 Money Supply. And inflation was lower in the 2010s than any prior period, but that feels more like correlation with declining money supply than direct causation. 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. 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. Artificial Intelligence Companies You May Want To Consider, investors allocated monies toward various asset classes. So far, so good. The information provided here is not investment, tax or financial advice. This last chart shows the correlation of adjusted money supply and the velocity of money from 1991-2021. 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. Learn more about the Econ Lowdown Teacher Portal and watch a tutorial on how to use our online learning resources. Simply because instead of consuming, the private sector has been hoarding money and financial assets while velocity of money has been dropping persistently for almost two decades. While M2 velocity is currently at historical lows, inflation is clearly not high. Reuters Summary Major U.S. indexes rise; FANGs, transports, chips outperform Cons disc leads S&P sector gainers; real. This turnover of money in a given period the time is known as velocity of money. This is a moderately strong relationship. M2 includes M1 (physical cash and checkable deposits) as well as "less liquid money", such as saving bank accounts. Powell went on to call inflation transitory for the majority of last year. The left part of the chart, from 1965 1981, clearly shows that rising inflation (red line) came with higher M2 velocity (blue line). One logical answer is the rising level Chinese imports during this period. Please let me know if this happens regularly @silvan_frank. These put persistent pressure on prices. 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. The money supplyis 100 for t = 0, 1. 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. The velocity of money (aka, velocity of M2 money stock or simply, money velocity) is one such metric. Charts powered by Highcharts. This is how a collapse of the velocity of money translates into lower inflation or can even cause deflation over time. The Quantity Theory of Money A Restatement. In. To ease credit during the pandemic, the central bank helped . Velocity of M2 Money Stock . We and our partners use data for Personalised ads and content, ad and content measurement, audience insights and product development. Is there such a relationship in the first place? One, M2 is partially endogenous to inflation (well, really NGDP). Youll notice the greater correlation and then decoupling. Why? One, M2 is partially endogenous to inflation (well, really NGDP. And why then would people suddenly decide to hoard money instead of spend it? Federal Reserve Bank of St. Louis, When the velocity of money declines, it can even offset an increase in money supply and lead to deflation instead of inflation. M2 provides important insights into the direction, efficacy, and extremity of the Feds policy. Or. https://www.econlib.org/archives/2015/10/everythings_end.html. Lucas Jr, Robert E. Two Illustrations of the Quantity Theory of Money. The American Economic Review 70, no. Reverse repos explain the surge in M1 relative to M2 in the lead chart. Comparing M2 vs M1 money supply Discussing massive increase in money supply in 2020-2021 First ever decline in money supply in 2022? Lucas Jr, Robert E. Two Illustrations of the Quantity Theory of Money. The American Economic Review 70, no. When confidence is restored, we should expect to see a rebound in the velocity of money. Meanwhile, Prof. Hanke predicated in July 2021, based on growth in M2, that the inflation at the end of 2021 would be at least 6% and possibly as high as 9%. 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? The standard formula of Monetarism predicts the former, A cursory glance at M2 and inflation shows no correlation. 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. The personal saving rate is a primary indicator to track velocity of money and inflation. The consent submitted will only be used for data processing originating from this website. A decreasing velocity of M1 might indicate fewer short- term consumption transactions are taking place. 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 . 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