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. Calculated as the ratio of quarterly nominal GDP to the quarterly average of M2 money stock. Related Categories . Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors. 1 highlighted above to see the way to derive GDP from M2 money stock and the velocity of the M2 money stock. This blog offers commentary, analysis and data from our economists and experts. LIVE MARKETS Will money velocity be a bigger inflation factor in 2022? This indicates the . 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 Market Implications Federal Reserve Bank of St. Louis; 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. 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. Then, why velocity of money may not mean anything for inflation after all. This could effectively pump the breaks on continued U.S. economic expansion and may even become a stronger headwind. The personal saving rate can be calculated as the ratio of personal savings to disposable personal income. Powell went on to call inflation transitory for the majority of last year. 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. 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. How could that not have resulted in higher prices? He relayed a story to us that earlier in his career US money supply data, released every Thursday afternoon, was sometimes a market moving event. What gives? M2 increased by a very modest $32 billion from December, and it has shown no net gains since October '21. https://www.econlib.org/archives/2015/10/everythings_end.html. In most recent history, M2 growth surpassed 10 percent in the crisis of 2001 and 2009, during which an expansionary monetary policy was deployed by the central bank, including large scale asset purchases. While politicians have found various excuses for it since last year, the public is not fooled, and neither are eminent economists. Historically, M2 has grown along with the economy (see in the chart below). Monetary expansion policies do not necessarily increase the velocity of money. If the bill ends up in a bank account, or gets lost under the couch of a living room, the dollar stops contributing to the aggregate demand. Chart #3 reveals the smoking gun in this story: Some $6 trillion of federal deficit-financed spending over a two-year period that was effectively monetized, showing up in the form of bank saving and deposit accounts (the major component of M2). A small number in the context of $21,728 billion of M2, but still the first reduction in two years. 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. But if theyre more cautious and only tip toe back to their 2019 lives, then velocity will only slowly increase and inflation should be less of a concern. 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. Explore resources provided by the Research Division at the Federal Reserve Bank of St. Louis. Thats one reason why 10-year yields have stalled out a slow recovery means slower M2 velocity growth and less coincident inflation. We and our partners use cookies to Store and/or access information on a device. 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. 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. 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. 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. Not anymore. When it goes up, M2 will. 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. MacMillan and Company Limited. Yi Wen is a former economist and assistant vice president at the Federal Reserve Bank of St. Louis. M2's huge growth . 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 . Categories > Money, Banking, & Finance > Monetary Data > Money Velocity. A higher MV figure means a dollar is cycling through domestic transactions for goods and services more frequently. The second is that Friedman preferred the divisia of M2. and (2) balances in retail Money Market Funds. R= -0.98 R^2 = 0.97. Further, it is lower than any time since 1960. Federal Reserve Bank of St. Louis, FRED Series Velocity of M2 Money Stock. The gap is closing, and the money printing presses have been shut down. If you have an ad-blocker enabled you may be blocked from proceeding. Essentially, this means that one USD cycled through the U.S. economy in Q4 2021 about. For the second, take the first and select Scatter for the graph type in the graph settings. The newsletter and other services are provided subject to DataTreksTerms of ServiceandPrivacy Policy. 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. This dynamic can have a huge impact on inflation. Explore resources provided by the Research Division at the Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, Source: Why even bother with it? Such an unprecedented increase in money demand has slowed down the velocity of money, as the figure below shows. Is that really a big deal given 2020 record 25% growth followed by 2021 12% growth? The answer lies in the private sectors dramatic increase in their willingness to hoard money instead of spend it. M2 is a measure of the money supply that includes cash, checking deposits, and easily convertible near money. One, M2 is partially endogenous to inflation (well, really NGDP). In any event, here we are; the flood of funny money is receding. Federal Reserve Bank of St. Louis Monetary Trends. See why for yourself by starting a 2-week FREE trial below. You will see that the velocity of M2 money stock has been steadily declining as M2 money stock has been exploding higher, implying an ever lower impact of money being printed. Year-over-year M2 growth is -1.7%, and 6-mo annualized growth is -3.4%. 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. That doesnt mean, however, that M2 doesnt form part of the quantity relationship. M2 increase of 20% to GDP followed by 3 years of 5% inflation. Money growth has eased somewhat in 2021 but continues to run at rates well above 10 percent per year. 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. 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. issn: 00028282.http://www.jstor.org/stable/1805778. If the velocity of money is increasing, then more transactions are occurring between individuals in an economy. Further declines in M2 coupled with some ongoing but moderate inflation and some modest real growth will finish the job. Comparing M2 vs M1 money supply Discussing massive increase in money supply in 2020-2021 First ever decline in money supply in 2022? The M2 money supply exploded from $15.5 trillion in February '20 to $21.5 trillion in January '22. Forbes Finance Council is an invitation-only organization for executives in successful accounting, financial planning and wealth management firms. Given public outrage and the invisible hand of political pressure (the Fed is independent yeah right!!! https://www.econlib.org/archives/2015/10/everythings_end.html. 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. The money supplyis 100 for t = 0, 1. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. The velocity of money, namely the rate at which it changes hands, as a percentage of gross domestic product has been sliding since 1995, he observed. Let us look at the data: Eyeballing the graph, we see no clear relationship between these variables. Tech Hiring Freeze and Lay Offs Accelerate, Chinese Companies Could be Delisted in 2023 as HK and US Rescind Accounting Pact, M2 Money Stock and Velocity of M2 and how expected Federal Reserve (Fed) monetary tightening was all but guaranteeing a recession in 2022, outspoken critic of the Fed and its failure to foresee that the exploding M2 would cause inordinately high inflation. The charts below illustrate this point. , where output is 150, the money velocity is 1.5. Do I qualify? High money velocity is usually associated with a healthy, expanding economy. Money velocity is a gauge of the consumers willingness to spend money. Can site, link, or share provided podcast website listed and sourced. Explore resources provided by the Research Division at the Federal Reserve Bank of St. Louis. The M2 for April 2022 is lower by $81.2 billion. Is velocity and inflation correlated? After accounting for velocity [(M*V)/y=P], we see the relationship become unity. Please enter your email address or username below. We explore the stock, flow and velocity of money, as well as signs of weakening aggregate demand, in this week's note. 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. A nice clean relationship. Reverse repos explain the surge in M1 relative to M2 in the lead chart. Oct 25, 2020. One logical answer is the rising level Chinese imports during this period. U.S. corporations are now sitting atop the highest corporate debt mountain in U.S. history. 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. 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). Ratio,Seasonally Adjusted, Frequency: He specialized in analysis of Federal Reserve policy and interest rate forecasting, and spearheaded the firm's research into Treasury Inflation Protected Securities (TIPS). 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. No. The relationship between money supply and velocity has significant implications for security markets going forward, particularly as it relates to inflation. In other words, MZM money is M2 money minus time deposits. Lucas Jr, Robert E. Two Illustrations of the Quantity Theory of Money. The American Economic Review 70, no. While M2 velocity is currently at historical lows, inflation is clearly not high. Inflation pressures peaked almost a year ago, and headline inflation will almost certainly continue to subside. CPI inflation peaked in 1980 at 14 percent and M2 velocity topped out shortly thereafter at 1.9x. Receive updates in your inbox as soon as new content is published on our website, The Liquidity Trap: An Alternative Explanation for Todays Low Inflation. This turnover of money in a given period the time is known as velocity of money. The consent submitted will only be used for data processing originating from this website. An example of data being processed may be a unique identifier stored in a cookie. Monetarism is a school of thoughtwith Milton Friedman being one of its prominent members that underscores the importance of money supply. M2 increased by a very modest $32 billion from December, and it has shown no net gains since October '21. Is this happening to you frequently? The velocity of MZM helps determine how often financial assets are switching hands within the economy. This indicates that 40% of the decrease in the velocity of money can be explained by the increase in the adjusted money supply. Friedman and Divisia Monetary Measures. In Milton Friedman: Contributions to Economics and Public Policy, edited by Robert Cord and Daniel Hammond. Further Information 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. Visit his blog: Calafia Beach Pundit (http://scottgrannis.blogspot.com/). Copyright 2023 Apple Inc. All rights reserved. To view the purposes they believe they have legitimate interest for, or to object to this data processing use the vendor list link below. 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. One Federal Reserve Bank Plaza, The opposite is also true: Money velocity decreases when fewer transactions are being made; therefore the economy is likely to shrink. Afterall, the formula for MV is simple: GDP/money supply. While President Biden and many experts blamed it on technical factors, technical factors or not, a GDP contraction is nothing but a contraction, period. Two, velocity plays a large factor in the relationship: It can be thought of as the rate of turnover in the money supply--that is, the number of times one dollar is used to purchase final goods and services included in GDP. Is there such a relationship in the first place? Views expressed are not necessarily those of the St. Louis Fed or Federal Reserve System. Please review the copyright information in the series notes before sharing. 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. What is the M1 money supply? Sumner, Scott. We dont yet know if or how that will alter inflation trends. 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 . This happened because the nominal interest rate on short-term bonds has declined essentially to zero, and, in this case, the best form of risk-free liquid asset is no longer the short-term government bonds, but money. Reuters Summary Major U.S. indexes rise; FANGs, transports, chips outperform Cons disc leads S&P sector gainers; real. MacMillan and Company Limited. 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:. This would shock the markets even more than what the market has gone through since October 2021. 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. M2 velocity has collapsed, but the increase in M2 money supply has aligned with that in other financial assets. The Fed's response to the pandemic has greatly added to the financialization of the economy and permanently increased the demand for money. Lucas Jr, Robert E. Two Illustrations of the Quantity Theory of Money. The American Economic Review 70, no. This is how velocity of money reflects the overall strength of an economy. 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. 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. However, that will depend on GDP remaining at least at its current level. Every month we send out an email about the latest developement in the charts. The problem is that velocity of money is never constant. Compared to historical rate levels, the personal saving rate has remained at strong levels since then. As velocity dropped through the 1980s, so did inflation. All this certainly explains why the S&P keeps making new highs . This is a change of 2.94% from last quarter and 7.36% from one year ago. Referencing data on MV from the Federal Reserve Bank of St. Louis, you can see something noteworthy. 2). This site requires JavaScript to run correctly. Strange as it may sound, we think the market has settled on the idea that American consumers will only slowly return to old habits. M2*V=P*Y. I have an alternative to all the "deflation" vs "inflation" debates - an environment that will be stable with just modest inflation . St. Louis, MO 63102, More 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. In my and my teams own research, as part of our investment committee decision-making discussions, we often like to seek out more obscure data. Quarterly. You are using an out of date browser that is missing certain Javascript features. According to the Quantity Theory of Money, inflation depends on the money supply and its velocity. Typically, increasing money velocity leads to higher inflation. Please, Is inflation always and everywhere a monetary phenomenon, or merely a, phenomenon? Wh m2 '' ^^ m2 . 2016. Report. 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. Friedman, Milton. 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. Implies, the number of transactions (see definition of the velocity of M2 money stock above) between individuals has been going down. The standard formula of Monetarism predicts the former. Amazon Return To Office Mandate, And Whats Happening With Amazon Stock? M2 Money Supply Shrinking vs Inflation | Money Velocity Irrelevant?. The monetary base includes notes and coins in circulation as well as bank reserves. His research interests include macroeconomics and the Chinese economy. M2 contained non-M1 components which are contractionary. 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%. Ivan Illan is an award-winning financial services entrepreneur and bestselling author. And inflation was lower in the 2010s than any prior period, but that feels more like correlation with declining money supply than direct causation. Put another way, the U.S. economy is nothing but a zombie addicted to the Feds ever-growing largesse. 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. CRN202504-2146319. Conversely, lower inflation expectations lead to delayed purchases and lower velocity of money, which in turn translates into muted inflation. 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. 5 (1980): 10051014. A declining M2 constitutes deflation. Explore resources provided by the Research Division at the Federal Reserve Bank of St. Louis. Consider M1, the narrowest component. The right side of the equation represents the Gross Domestic product. The issue has to do with the velocity of money, which has never been constant, as can be seen in the figure below. 5 (1980): 10051014. The Quantity Theory of Money A Restatement. In. Are labor supply and labor demand out of balance? Conversely, a lower figure would mean the exact opposite, which could indicate a slowing economic backdrop. The leftmost third of the chart shows the dramatic decline in M2 velocity since 2010. If not cycling through transactions, where did all that newly minted money go? Friedman, Milton. 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). 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. Please. Year-over-year M2 growth is -1.7%, and 6-mo annualized growth is -3.4%. Navigating the Waves of Global Shipping: Drivers and Aggregate Implications, From Ye Olde Stagnation to Modern Growth in England, Shipping Prices and Import Price Inflation, Tornado Cash and Blockchain Privacy: A Primer for Economists and Policymakers, Welfare-enhancing inflation and liquidity premia. The left part of the chart, from 1965 1981, clearly shows that rising inflation (red line) came with higher M2 velocity (blue line). 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. The information provided here is not investment, tax or financial advice. How is velocity of money calculated? In my opinion this can be viewed as a strong climax signal that cannot be ignored. Some of our partners may process your data as a part of their legitimate business interest without asking for consent. 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 supports the intervention of central banks to manage business cycles by targeting an adequate growth rate of money supply. 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. 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. , published 1969. Oxford University Press. , Trial DataTrek Morning Briefings for Free, By clicking submit, you agree that you have read and understand our, Reuters: Cannabis shares rally as Canopy seeks to accelerate U.S. market entry. Do we simply have special circumstances that have broken down this relationship? Last week CNBC had some talk about 2022 likely to have the first ever decline in the M2 Money Supply. Chart #2 shows the 6-mo. 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.
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