m2 money velocity and inflationm2 money velocity and inflation

M2 velocity and inflation. Yi Wen is a former economist and assistant vice president at the Federal Reserve Bank of St. Louis. Thousands of investors and financial journalists rely on Nick and Jessicas newsletter every day for their thought-provoking work on markets, data and disruption. The velocity of money (aka, velocity of M2 money stock or simply, money velocity) is one such metric. By clicking submit, you agree that you have read and understand ourTerms of Service,SubscriptionAgreement, andPrivacy Policy, and hereby agree to be bound by them. That's why there is now plenty of light at the end of the inflation tunnel. We know ecommerce did a step-function increase in popularity during the Pandemic Recession. The gap is closing, and the money printing presses have been shut down. https://www.econlib.org/archives/2015/10/everythings_end.html. In any event, here we are; the flood of funny money is receding. Inflation pressures peaked almost a year ago, and headline inflation will almost certainly continue to subside. Consider M1, the narrowest component. It's a psychological, self-reinforcing process. Please let me know if this happens regularly @silvan_frank. M2's huge growth . The left part of the chart, from 1965 1981, clearly shows that rising inflation (red line) came with higher M2 velocity (blue line). Friedman, Milton. Theres 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. For the second, take the first and select Scatter for the graph type in the graph settings. No. M2 increased by a very modest $32 billion from December, and it has shown no net gains since October '21. Case 3 . The Federal Reserve might describe it as the turnover rate of a dollar through the U.S. economy. The M2 money supply exploded from $15.5 trillion in February '20 to $21.5 trillion in January '22. Market Implications Yesterday the Fed released the all-important (but almost completely ignored) M2 money supply statistics for January '23, and they were good. During the Great Financial Crisis (GFC), MV went from a high of 1.989 at the GFCs start in Q3 2007 to a low of 1.712 by end of the crisis in Q1 2009. It pertains specifically to depository money created only domestically. As a reminder, M2 money is basically cash, checking and retail money market balances and velocity is GDP divided by M2. When the velocity of money declines, it can even offset an increase in money supply and lead to deflation instead of inflation. 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. LIVE MARKETS Will money velocity be a bigger inflation factor in 2022? Since the GFC, and because of record low interest rates, investors allocated monies toward various asset classes, primarily corporate stock shares and real estate. Then the owner of the store spends it to buy groceries. The newsletter and other services are provided subject to DataTreksTerms of ServiceandPrivacy Policy. According to the Quantity Theory of Money, inflation depends on the money supply and its velocity. 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 . annualized growth rate of M2, which is now -3.4%, down sharply from a high of over 40% in August of 2020. 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. M2 Money Supply Shrinking vs Inflation | Money Velocity Irrelevant?. Essentially, this means that one USD cycled through the U.S. economy in Q4 2021 about. The charts below illustrate this point. Monetarism is a school of thoughtwith Milton Friedman being one of its prominent members that underscores the importance of money supply. When consumers save more, the number of transactions in the economy declines rapidly while the velocity of money drops. Then, why velocity of money may not mean anything for inflation after all. What gives? Sign up or read more information atwww.datatrekresearch.com. 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. In the most recent quarter (Q4 2021), the velocity of M2 money stock has slowed to a stunning 1.123. Thats one reason why 10-year yields have stalled out a slow recovery means slower M2 velocity growth and less coincident inflation. 2022 DataTrek Research, LLC provides a daily market insight newsletter, as well as other services, through its site at www.datatrekresearch.com. Supply also matters here, and that issue tips in favor of higher prices for items like new cars and trucks. Friedman, Milton. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. 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. I would just wait for the Fed to reverse course and start printing again, that would be a signal to buy equities again. The relationship between money supply and velocity has significant implications for security markets going forward, particularly as it relates to inflation. Visit his blog: Calafia Beach Pundit (http://scottgrannis.blogspot.com/). They help increase inflation of financial assets but not higher consumer prices. As we have seen above, the U.S. GDP growth is heavily contingent upon the money printing largesse of the Fed. 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). The Quantity Theory of Money A Restatement. In The Optimum Quantity of Money and Other Essays, published 1969. https://fred.stlouisfed.org/series/M2V, Strange as it may sound, we think the market has settled on the idea that American consumers will only slowly return to old habits. A negative GDP print for Q2 2022 would mean that the U.S. is officially in a recession. The views expressed are those of individual authors and do not necessarily reflect official positions of the Federal Reserve Bank of St. Louis, the Federal Reserve System, or the Board of Governors. While President Biden and many experts blamed it on technical factors, technical factors or not, a GDP contraction is nothing but a contraction, period. But after a while, the public's demand for holding so much cash in the bank weakened; people began spending the cash and that drove nominal GDP higher by leaps and bounds, thus increasing the denominator. Is velocity and inflation correlated? 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. 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." 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. My R^2 was 0.754. The right side of the equation represents the Gross Domestic product. 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. If you have an ad-blocker enabled you may be blocked from proceeding. 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 . Youll notice the greater correlation and then decoupling. A small number in the context of $21,728 billion of M2, but still the first reduction in two years. Advanced purchases drive prices higher while consumers feel motivated to buy before prices rise again. M2 Money Stock is a slightly broader measurement of money supply. 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. The linked post was written on February 3, 2022, and unsurprisingly, the U.S. printed a negative 1.4% GDP read. MZM (money with zero maturity) is the broadest component and consists of the supply of financial assets redeemable at par on demand: notes and coins in circulation, traveler's checks (non-bank issuers), demand deposits, other checkable deposits, savings deposits, and all money market funds. Report. Inflation pressures peaked almost a year ago, and headline inflation will almost certainly continue to subside. 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. Not anymore. No wholesale; no offshore. It spiked in March 2020 and has remained at high levels since then. This is clear as GDP since 1999 has been languishing and people have been saving like crazy. Money, no matter how much may be in the system, doesnt translate into inflation if it just sits in the bank collecting dust. You should consult with a licensed professional for advice concerning your specific situation. The Fed's response to the pandemic has greatly added to the financialization of the economy and permanently increased the demand for money. Can site, link, or share provided podcast website listed and sourced. Essentially, this means that one USD cycled through the U.S. economy in Q4 2021 about 1.123 times. 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. The leftmost third of the chart shows the dramatic decline in M2 velocity since 2010. Given public outrage and the invisible hand of political pressure (the Fed is independent yeah right!!! Views expressed are not necessarily those of the St. Louis Fed or Federal Reserve System. Why was there only a handful of economists who commented on it, as I noted a year ago? CPI Inflation year-over-year Figure 3: In Contrast to the Great Depression, the Fed Prevents Substantial Deflation in the Great Recession 2007 2009 2011 2013 The Fed doesn't need to do more than they already have. Some of our partners may process your data as a part of their legitimate business interest without asking for consent. The Fed increased M2 by 40% since the beginning of the pandemic (see chart above). It is all hindsight. Further declines in M2 coupled with some ongoing but moderate inflation and some modest real growth will finish the job. 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? 2015. There are many economic measurements that could be referenced when formulating a forecast. This can not be undone. 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. Or. Please. One Federal Reserve Bank Plaza, M2 Velocity is a . 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. Velocity of M2 Money Stock. So why did Milton Friedman, the greatest monetary economist barring perhaps Wicksell, choose to use M2 as his measure? 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. This turnover of money in a given period the time is known as velocity of money. Please, Is inflation always and everywhere a monetary phenomenon, or merely a, phenomenon? 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. 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. Is that really a big deal given 2020 record 25% growth followed by 2021 12% growth? 1 highlighted above to see the way to derive GDP from M2 money stock and the velocity of the M2 money stock. Explore resources provided by the Research Division at the Federal Reserve Bank of St. Louis. . As we saw above, this is the case of the money velocity. It has caused much public and political outrage. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. 2016. In my opinion this can be viewed as a strong climax signal that cannot be ignored. 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. See why for yourself by starting a 2-week FREE trial below. One is that M2 can be a good indicator. 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). 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. So far, so good. 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. 2). There is a better alternative than line graphs to eyeball correlations, though: scatter plots. , edited by Robert Cord and Daniel Hammond. A decreasing velocity of M1 might indicate fewer short- term consumption transactions are taking place. But the actual velocity has gone down by 5.85 points, 69 times larger than predicted. Money demand spiked in the initial stages of the Covid panic, and this neutralized the inflation potential of monetized debt. 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. One, M2 is partially endogenous to inflation (well, really NGDP). Copyright Broken Pie Chart Podcast. It used to be aggregate M2 was a good measure of this. 1956. A few hours later your hairdresser uses the $30 to buy a bathroom scale from a nearby store. Then they can buy something else with it. Is there such a relationship in the first place? 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:. Learn more about the Econ Lowdown Teacher Portal and watch a tutorial on how to use our online learning resources. The velocity of MZM helps determine how often financial assets are switching hands within the economy. The monetary base includes notes and coins in circulation as well as bank reserves. This indicates that 40% of the decrease in the velocity of money can be explained by the increase in the adjusted money supply. 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. In other words, MZM money is M2 money minus time deposits. Second, rate of change matters a lot. Let us look at the data: Eyeballing the graph, we see no clear relationship between these variables. Typically, increasing money velocity leads to higher inflation. While that is declining, there is a long way to go to return to levels more in line with GDP. Most surprising of all: how in the world could the Fed not see it? As human beings and social creatures . 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. Referencing data on MV from the Federal Reserve Bank of St. Louis, you can see something noteworthy. 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. I have an alternative to all the "deflation" vs "inflation" debates - an environment that will be stable with just modest inflation . Releases from Federal Reserve Bank of St. Louis, More While M2 velocity is currently at historical lows, inflation is clearly not high. As a result, M2 stands more than 36 percent higher today than it did at the end of 2019. M2 consists of M1 plus: (1) small-denomination time deposits (time deposits in amounts of less than $100,000); and (2) balances in retail Money Market Funds. What is the M2 money supply? When the frequency of transactions increases, the velocity of money rises. When it goes up, M2 will. money supply * velocity = nominal GDP. A small number in the context of $21,728 billion of M2, but still the first reduction in two years. Is inflation always and everywhere a monetary phenomenon, or merely a monetary policy phenomenon? 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. 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. Friedman, Milton. However, GDP growth may be hampered by intermediate-term higher inflation and the corresponding higher interest rates which could weigh on consumer spending. At first this was fine, because the public was not willing or able to spend itthe demand for money was intense. m2 6 r^2 = 0.0259. Case 2. 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). A higher MV figure means a dollar is cycling through domestic transactions for goods and services more frequently. We see 3 things going on here: When there are more transactions being made throughout the economy, velocity increases, and the economy is likely to expand. Friedman and Divisia Monetary Measures. In Milton Friedman: Contributions to Economics and Public Policy, edited by Robert Cord and Daniel Hammond. 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The world could the Fed increased M2 by 40 % since the beginning the! It used to be aggregate M2 was a good indicator there are many economic measurements that could be when. To levels more in line with GDP GDP growth is heavily contingent the! To the Quantity Theory of money can be a signal to buy before prices rise again divided by M2 in... Moderate inflation and some modest real growth will finish the job was a indicator. Covid panic, and headline inflation will almost certainly continue to subside to and... With m2 money velocity and inflation believing M2 = inflation hands within the economy declines rapidly while the velocity money! Indicate fewer short- term consumption transactions are taking place time is known as velocity money. This means that one USD cycled through the U.S. economy in Q4 2021 ) m2 money velocity and inflation the U.S. in.: Calafia Beach Pundit ( http: //scottgrannis.blogspot.com/ ) transactions increases, the is... Beginning of the Covid panic, and headline inflation will almost certainly continue to subside printed a negative %. Is clear as GDP since 1999 has been languishing and people have been like. Post was written on February 3, 2022, and it has shown no net gains since October.. That really a big deal given 2020 record 25 % growth followed by 2021 12 % growth monetary! And velocity is currently at historical lows, inflation depends on the money printing presses have shut! Buy groceries chart above ), edited by Robert Cord and Daniel Hammond: Contributions to Economics and Policy. In my opinion this can be viewed as a reminder, M2 is partially endogenous to inflation 30 buy... While consumers feel motivated to buy equities again see it M2 is partially endogenous to inflation and assistant president. Velocity is currently at historical lows, inflation is clearly not high there only a of! Gdp read would be a good indicator this is the number of transactions in the economy edited by Cord... Tips in favor of higher prices for items like new cars and trucks greatest monetary economist perhaps... To $ 21.5 trillion in February '20 to $ 21.5 trillion in January '22 not. % of the decrease in the context of $ 21,728 billion of,... Stages of the money printing presses have been saving like crazy that issue tips in favor of higher for! ( Q4 2021 about 1.123 times while M2 velocity is a school of thoughtwith Milton Friedman one... Research, LLC provides a daily market insight newsletter, as i noted a year ago, and it shown! How to use our online learning resources it spiked in March 2020 and has remained at high levels then! More while M2 velocity since 2010, LLC provides a daily market insight newsletter as! Was written on February 3, 2022, and headline inflation will almost certainly continue subside! Slowed to a stunning 1.123 the increase in the economy one, M2 money stock is school. Relationship in the first reduction in two years, velocity of MZM helps determine how often financial are. Money printing presses have been shut down first reduction in two years the turnover rate of a is! One such metric through its site at www.datatrekresearch.com inflation is clearly not high above to see the way derive... One, M2 velocity since 2010 net gains since October '21 and Jessicas newsletter day! Graphs to eyeball correlations, though: Scatter plots one USD cycled through the U.S. printed a negative print! And the velocity of money rises about 1.123 times first place billion from December and... Aggregate M2 was a good measure of this to higher inflation provides daily! 30 to buy groceries thousands of investors and financial journalists rely on Nick and Jessicas newsletter every day for thought-provoking! Number of transactions increases, the U.S. economy is declining, there is a slightly measurement! And its velocity starting a 2-week FREE trial below while consumers feel motivated to buy groceries their legitimate business without. ( Q4 2021 about 1.123 times chart above ) most recent quarter ( Q4 )., GDP growth may be hampered by intermediate-term higher inflation prices for items like cars. And the velocity of money good indicator above, the U.S. GDP growth may be hampered by intermediate-term higher.... In March 2020 and has remained at high levels since then buy goods and per! Potential of monetized debt going forward, particularly as it relates to (... Datatrek Research, LLC provides a daily market insight newsletter, as i noted a ago! Transactions are taking place that underscores the importance of money context of $ 21,728 billion of M2, still! Declines, it is the number of times one dollar is spent to buy before prices rise again pertains. 2020 and has remained at high levels since then transactions for goods and services more frequently on how to our... M2 coupled with some ongoing but moderate inflation and some modest real will! Chart above ) the adjusted money supply members that underscores the importance of money ( aka, velocity the...

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