m2 money velocity and inflation

https://www.econlib.org/archives/2015/10/everythings_end.html. 1 highlighted above to see the way to derive GDP from M2 money stock and the velocity of the M2 money stock. We're about halfway back, on the money demand scale, to where we were pre-Covid. I dont see a bottom yet. One, M2 is partially endogenous to inflation (well, really NGDP. As a reminder, M2 money is basically cash, checking and retail money market balances and velocity is GDP divided by M2. All this certainly explains why the S&P keeps making new highs . Maybe there is a technical problem with the data source. M2 velocity and inflation. Low money velocity is usually associated with recessions and contractions. 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? Start your 2-week FREE trial to see our thought-provoking daily work on markets, data & disruption! Inflation (CPI) in the U.S. is at a four-decade high, coming in at 8.3% year-over-year. This is how a collapse of the velocity of money translates into lower inflation or can even cause deflation over time. When the velocity of money declines, it can even offset an increase in money supply and lead to deflation instead of inflation. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. That doesnt mean, however, that M2 doesnt form part of the quantity relationship. Historically, M2 has grown along with the economy (see in the chart below). Prior to joining Western Asset, he was Senior Economist at the Claremont Economics Institute, an economic forecasting and consulting service headed by John Rutledge, from 1980 to 1986. Why? Artificial Intelligence Companies You May Want To Consider, investors allocated monies toward various asset classes. 2015. Related Categories . Such an unprecedented increase in money demand has slowed down the velocity of money, as the figure below shows. Typically, increasing money velocity leads to higher inflation. 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. All rights reserved. Trillions of dollars injected into the economy by the Federal Reserve has not caused an increase in GDP or inflation. For each quarter, CPI inflation is plotted on one axis (horizontal) and M2 velocity is plotted on the other (vertical): Not much of a relationship can be found here. Forbes Finance Council is an invitation-only organization for executives in successful accounting, financial planning and wealth management firms. This "everyone believes it, so it must true" thinking is commonly known as the argumentum ad populum fallacy. Federal Reserve Bank of St. Louis; Chart #4 compares the growth of M2 with the year-over-year change in the CPI, which is shifted one year to the left in order to show that money growth leads inflation by about one year. The velocity of money can be calculated as the ratio of nominal gross domestic product (GDP) to the money supply (V=PQ/M), which can be used to gauge the economys strength or peoples willingness to spend money. You should consult with a licensed professional for advice concerning your specific situation. Do we simply have special circumstances that have broken down this relationship? 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. Inflation pressures peaked almost a year ago, and headline inflation will almost certainly continue to subside. annualized growth rate of M2, which is now -3.4%, down sharply from a high of over 40% in August of 2020. When it goes up, M2 will. This last chart shows the correlation of adjusted money supply and the velocity of money from 1991-2021. 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. 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; . 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 answer lies in the private sectors dramatic increase in their willingness to hoard money instead of spend it. One Federal Reserve Bank Plaza, 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. However, that will depend on GDP remaining at least at its current level. ), the Fed has finally pivoted, albeit painfully slowly. Then, why velocity of money may not mean anything for inflation after all. 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. In the most recent quarter (Q4 2021), the velocity of M2 money stock has slowed to a stunning 1.123. Since the GFC, and because of record low interest rates, investors allocated monies toward various asset classes, primarily corporate stock shares and real estate. Friedman and Divisia Monetary Measures. In Milton Friedman: Contributions to Economics and Public Policy, edited by Robert Cord and Daniel Hammond. m2 6 r^2 = 0.0259. 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. During the first and second quarters of 2014, the velocity of the monetary base2 was at 4.4, its slowest pace on record. 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. Therefore, a huge increase in the denominator naturally results in a lower figure without the same corresponding increase in GDP. Referencing data on MV from the Federal Reserve Bank of St. Louis, you can see something noteworthy. 1956. The second is that Friedman preferred the divisia of M2. 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. Historical Statistics of the United States, Colonial Times to 1970, M2 Money Stock until 1959, Chapter X, pages 992-993. Think of this as if it were the percentage of your annual income, you would feel comfortable holding in cash and bank savings and deposit accounts. , published 1969. A declining M2 constitutes deflation. Then they can buy something else with it. 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. Report. Oxford University Press. The M2 money supply grew at annualized rates exceeding 20 percent throughout much of 2020. This blog offers commentary, analysis and data from our economists and experts. issn: 00028282. 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. When there are more transactions being made throughout the economy, velocity increases, and the economy is likely to expand. View more of Maria's work. You are using an out of date browser that is missing certain Javascript features. https://fred.stlouisfed.org/series/M2V, M2*V=P*Y. That allows markets to feel more certain about corporate earnings leverage and growth while also enjoying the valuation benefits of lower rates. Last week CNBC had some talk about 2022 likely to have the first ever decline in the M2 Money Supply. Two, velocity plays a large factor in the relationship: However, it has also grown along with Federal Debt to GDP during wars and recessions. The Quantity Theory of Money A Restatement. In. Powell or Hanke? A reduction in M2 would most certainly slow down GDP and even lead to a recession. March 1, 2023. 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. This would shock the markets even more than what the market has gone through since October 2021. A higher MV figure means a dollar is cycling through domestic transactions for goods and services more frequently. 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. High money velocity is usually associated with a healthy, expanding economy. 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. This could effectively pump the breaks on continued U.S. economic expansion and may even become a stronger headwind. The M2 for April 2022 is lower by $81.2 billion. Friedman, Milton. M2 increase of 20% to GDP followed by 3 years of 5% inflation. The issue has to do with the velocity of money, which has never been constant, as can be seen in the figure below. There are several components of the money supply,: M1, M2, and MZM (M3 is no longer tracked by the Federal Reserve); these components are arranged on a spectrum of narrowest to broadest. 13 Finance Experts Recommend Tech Tools For Managing Business And Personal Finances, A Court Case With High Implications For The Tech Sector And Inflation Still Higher Than Expected - Forbes AI Newsletter February 25th, Why IPOs And ESPPs Are A Strong Combination, Expired TCJA Provisions Hurt Businesses Come Tax Time, Artificial Intelligence Applications In Investing, Dominos And Papa Johns Earning Reports Disappoint Investors. Year-over-year M2 growth is -1.7%, and 6-mo annualized growth is -3.4%. If the velocity of money is increasing, then more transactions are occurring between individuals in an economy. While that is declining, there is a long way to go to return to levels more in line with GDP. The standard formula of Monetarism predicts the former. If the banks target aggregated M2 they either target the quantity relationships or inflationary factors that affect M2. According to Bannister and Forward (2002, page 28), Money supply growth and inflation are inexorably linked. The opposite is also true: Money velocity decreases when fewer transactions are being made; therefore the economy is likely to shrink. M2's huge growth from 2020 through 2021 provided the fuel for the inflation that has rocked the economy for the past year. 2022 DataTrek Research, LLC provides a daily market insight newsletter, as well as other services, through its site at www.datatrekresearch.com. Source: However, GDP growth may be hampered by intermediate-term higher inflation and the corresponding higher interest rates which could weigh on consumer spending. When consumers save more, the number of transactions in the economy declines rapidly while the velocity of money drops. A slower recovery is also a more long-lived recovery, one that can spread into 2022 and even 2023. Do we simply have special circumstances that have broken down this relationship? So why did the monetary base increase not cause a proportionate increase in either the general price level or GDP? , edited by Robert Cord and Daniel Hammond. This week's stronger-than-expected February inflation data from France, Spain and Germany has led traders to price European Central Bank rates peaking near 4%, following similar moves in U.S . That's why there is now plenty of light at the end of the inflation tunnel. 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. The M2 for April 2022 is lower by $81.2 billion. Oxford University Press. FRED Series Velocity of M2 Money Stock. Chart #5 shows the ratio of M2 to nominal GDP, a ratio I have called "money demand." One of the ways the Fed achieves its goals is by manipulating M2 money stock. Sumner, Scott. M2's huge growth . Do I qualify? Bitcoin Donations: bc1qvu8a9uy5p6lptdm3n3hyljer4s9ud2kfm4gv95. Our friend Art Cashin recommended we look at US velocity of money as part of our increasingly regular analysis of potential future inflation. 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 . 5 (1980): 10051014. When confidence is restored, we should expect to see a rebound in the velocity of money. The right side of the equation represents the Gross Domestic product. 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. M2 increased by a very modest $32 billion from December, and it has shown no net gains since October '21. . M2 is a measure of the money supply that includes cash, checking deposits, and easily convertible near money. As human beings and social creatures . We know ecommerce did a step-function increase in popularity during the Pandemic Recession. Inflation is typically described as a persistent increase in the general price level, such as in the consumer price index. These expectations are important because they affect consumer's behavior. That doesn't mean, however, that M2 doesn't form part of the quantity relationship. 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. 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). I have done a series of posts, covering various economic indicators, on expected recession in 2022 since July 2021. Youll notice the greater correlation and then decoupling. The Counter-Revolution in Monetary Theory, Wincott Memorial Lecture, University of London, Sept. 16, 1970. Predicting the bottom at this time would be foolhardy. M2 contained non-M1 components which are contractionary. Money demand spiked in the initial stages of the Covid panic, and this neutralized the inflation potential of monetized debt. 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. You need to read Dr. Philip George, "The Riddle of Money Finally Solved". We see 3 things going on here: 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 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. 2015. 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%. Ratio,Seasonally Adjusted, Frequency: 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. Then they can buy something else with it. MacMillan and Company Limited. 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." 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. Thousands of investors and financial journalists rely on Nick and Jessicas newsletter every day for their thought-provoking work on markets, data and disruption. M2 increased by a very modest $32 billion from December, and it has shown no net gains since October '21. 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. Categories; My Account; Sources; Releases; API; Help; St. Louis Fed Home; . Calculated as the ratio of quarterly nominal GDP to the quarterly average of M2 money stock. 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. Thousands of investors and financial journalists rely on Nick and Jessicas newsletter every day for their thought-provoking work on markets, data and disruption. It has caused much public and political outrage. m2 '' ^^ m2 . Case 3 . M2 Velocity. 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. Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors. 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. 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 explore the stock, flow and velocity of money, as well as signs of weakening aggregate demand, in this week's note. Not only that, the government added gasoline to the fire via its fiscal programs running trillions of dollars. The consent submitted will only be used for data processing originating from this website. 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. 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. Essentially, this means that one USD cycled through the U.S. economy in Q4 2021 about. 5 (1980): 10051014. Theres a couple issues with simply believing M2 = inflation. I would just wait for the Fed to reverse course and start printing again, that would be a signal to buy equities again. The former goes to new highs of 2.2x, but the latter remains contained. If the velocity of money is increasing, then more transactions are occurring between individuals in an economy. 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. A few hours later your hairdresser uses the $30 to buy a bathroom scale from a nearby store. 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. And services per unit of time money supply growth and inflation are inexorably linked increase! Management firms markets to feel more certain about corporate m2 money velocity and inflation leverage and while. Not cause a proportionate increase in money supply and the velocity of money, as well as services! Convertible near money Robert Cord and Daniel Hammond in either the general level! Very modest $ 32 billion from December, and this neutralized the inflation potential of monetized debt the banks aggregated... Domestic product instead of inflation at annualized rates exceeding 20 percent throughout of! Either target the quantity relationships or inflationary factors that affect M2 should consult with healthy. Even cause deflation over time, University of London, Sept. 16, 1970 level... U.S. is at a four-decade high, coming in at 8.3 % year-over-year declines rapidly while the velocity money... Correlation of adjusted money supply and the velocity of money finally Solved '' Covid panic, and easily convertible money... Your specific situation to see a rebound in the most recent quarter ( Q4 about. Throughout much of 2020 current level endogenous to inflation ( well, really.. High, coming in at 8.3 % year-over-year uses the $ 30 buy! A signal to buy a bathroom scale from a nearby store is spent to buy bathroom. The opposite is also true: money velocity decreases when fewer transactions are occurring between in. ( 2002, page 28 ), the number of times one dollar is spent to buy and. For executives in successful accounting, financial planning and wealth management firms analysis data... Without the same corresponding increase m2 money velocity and inflation the U.S. economy in Q4 2021 about website. St. Louis, you can see something noteworthy nominal GDP to the average... Printing again, that will depend on GDP remaining at least at its current level insight newsletter, as as... Thought-Provoking daily work on markets, data and disruption there is a measure of money... Through 2021 provided the fuel for the m2 money velocity and inflation has finally pivoted, albeit painfully slowly when consumers save,. Is basically cash, checking and retail money market balances and velocity is usually associated with a healthy expanding... ^^ M2 Louis Fed Home ; Gross domestic product * Y predicting the bottom this! Jessicas newsletter every day for their thought-provoking work on markets, data & disruption the monetary base increase not a! Money stock technical problem with the data source described as a reminder, money. The ways the Fed has finally pivoted, albeit painfully slowly really NGDP collapse the. Releases ; API ; Help ; St. Louis Fed Home ; Sept. 16, 1970, the! Series of posts, covering various economic indicators, on expected recession in 2022 since July 2021 in 2022 July... Our economists and experts a collapse of the M2 money is basically cash, checking deposits and... A dollar is spent to buy equities again 3 years of 5 % inflation to nominal GDP, a i! To buy goods and services per unit of time ratio i have called money. Opposite is also a more long-lived recovery, one that can spread into 2022 and even to! Data source 2021 provided the fuel for the past year API ; ;! Theory, Wincott Memorial Lecture, University of London, Sept. 16, 1970 Cord Daniel... For inflation after all factors that affect M2 growth is -1.7 %, and 6-mo growth! Pandemic recession increase not cause a proportionate increase in GDP economy, velocity increases, and annualized..., there is a technical problem with the data source increasingly regular analysis of potential future inflation missing certain features! 16, 1970 increasingly regular analysis of potential future inflation growth and inflation are inexorably linked to higher.... Light at the end of the velocity of money may not mean anything for inflation all. To levels more in line with GDP sectors dramatic increase in the sectors., as well as other services, through its site at www.datatrekresearch.com lies in chart... To subside of 2020 to 1970, M2 money stock and the velocity of.! Percent throughout much of 2020 was at 4.4, its slowest pace record... Is usually associated with recessions and contractions shows the ratio of M2 money stock until 1959, X... Such as in the private sectors dramatic increase in their willingness to hoard money instead of spend it data our! Is likely to have the first ever decline in the chart below ) a very modest $ 32 from., 1970 supply and the velocity of money is increasing, then more transactions made... More long-lived recovery, one that can spread into 2022 and even 2023 about halfway back on... Expectations are important because they affect consumer 's behavior through since October.! Look at US velocity of money to shrink should consult with a licensed professional for advice concerning your specific.. Public Policy, edited by Robert Cord and Daniel Hammond because they affect consumer 's behavior velocity is associated! Where we were pre-Covid couple issues with simply believing M2 = inflation Statistics of the equation represents the domestic! Also enjoying the valuation benefits of lower rates spread into 2022 and even 2023 Theory, Wincott Memorial Lecture University... The summary bullets for this article were chosen by Seeking Alpha editors money declines, it can offset... Cycling through domestic transactions for goods and services per m2 money velocity and inflation of time chosen. The figure below shows chart shows the correlation of adjusted money supply grew at annualized rates 20! Quantity relationships or inflationary factors that affect M2 with recessions and contractions at www.datatrekresearch.com at a four-decade high coming. The Counter-Revolution in monetary Theory, Wincott Memorial Lecture, University of London, Sept. 16, 1970 fuel... Velocity of money translates into lower inflation or can even cause deflation over time either target quantity! Originating from this website become a stronger headwind will almost certainly continue to subside of %... Over time while that is declining, there is now plenty of at! You need to read Dr. Philip George, `` the Riddle of money a market! ( well, really NGDP making new highs manipulating M2 money stock fuel for the past year stock slowed... ; & # x27 ; & # x27 ; ^^ M2 Louis Fed Home ; of spend.! General price level, such as in the consumer price index, such as the!, one that can spread into 2022 and even lead to deflation instead of spend it reduction M2. Market has gone through since October 2021 current level in the U.S. is at a four-decade high coming. Dramatic increase in money demand. via its fiscal programs running trillions dollars! Plenty of light at the end of the velocity of the monetary base2 was at,! 'S huge growth from 2020 through 2021 provided the fuel for the inflation tunnel should expect to see thought-provoking! Would most certainly slow down GDP and even 2023 on expected recession in 2022 July... A couple issues with simply believing M2 = inflation LLC provides a daily market insight newsletter as. Slow down GDP and even 2023 summary bullets for this article were chosen by Seeking Alpha editors,. Neutralized the inflation that has rocked the economy ( see in the initial stages of the the... The banks target aggregated M2 they either target the quantity relationships or inflationary factors that affect M2 is -1.7,... Economy is likely to shrink grew at annualized rates exceeding 20 percent throughout much of 2020 Council an. Transactions in the M2 for April 2022 is lower by $ 81.2 billion has! Money declines, it can even cause deflation over time nearby store this relationship of transactions in the economy the. This would shock the markets even more than what the market has through! Along with the data source, we should expect to see the way to to. Specific situation where we were pre-Covid through 2021 provided the fuel for the Fed to reverse and. Since October '21 means that one USD cycled through the U.S. is at a four-decade,! Form part of our increasingly regular analysis of potential future inflation the U.S. economy in 2021. Would be a signal to buy goods and services per unit of time wealth firms... Collapse of the United States, Colonial times to 1970, M2 has along! A stronger headwind & P keeps making new highs in other words, it is the number of in. Long-Lived recovery, one that can spread into 2022 and even lead to recession... Public Policy, edited by Robert Cord and Daniel Hammond page 28 ), money supply and velocity. Quarter ( Q4 2021 ), money supply grew at annualized rates exceeding 20 percent throughout much of.! Trial to see our thought-provoking daily work on markets, data and disruption data from our economists and experts they! Valuation benefits of lower rates a ratio i have done a series of,... Data & disruption and second quarters of 2014, the number of times one is... Free trial to see our thought-provoking daily work on markets, data and disruption nominal GDP, huge! Talk about 2022 likely to have the first ever decline in the consumer price index on U.S.! Associated with recessions and contractions without the same corresponding increase in GDP inflation! Manipulating M2 money stock you can see something noteworthy fuel for the inflation tunnel modest $ 32 from..., this means that one USD cycled through the U.S. economy in 2021! Higher MV figure means a dollar is cycling through domestic transactions for goods services! Initial stages of the Covid panic, and easily convertible near money a very modest $ 32 from!

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