We dont yet know if or how that will alter inflation trends. The issue has to do with the velocity of money, which has never been constant, as can be seen in the figure below. 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. That doesnt mean, however, that M2 doesnt form part of the quantity relationship. 1 highlighted above to see the way to derive GDP from M2 money stock and the velocity of the M2 money stock. There are many economic measurements that could be referenced when formulating a forecast. That's how much cash Americans had in their wallets, their checking accounts, and their short-term savings accounts. A Technical Approach. 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. After accounting for velocity [(M*V)/y=P], we see the relationship become unity. 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. The personal saving rate is a primary indicator to track velocity of money and inflation. When the velocity of money declines, it can even offset an increase in money supply and lead to deflation instead of inflation. As we have seen above, the U.S. GDP growth is heavily contingent upon the money printing largesse of the Fed. See why for yourself by starting a 2-week FREE trial below. If you have an ad-blocker enabled you may be blocked from proceeding. 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). One of the most important theories to explain inflation is the monetarist view that, according to Milton Friedman, Inflation is always and everywhere a monetary phenomenon.1 In other words, inflation occurs because there is too much money available to buy the same amount of goods and services produced in the economy. 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:. We know ecommerce did a step-function increase in popularity during the Pandemic Recession. Now surprisingly, MV is 34.4% lower than where it was at coming out of the GFC. 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. It's a psychological, self-reinforcing process. Last week CNBC had some talk about 2022 likely to have the first ever decline in the M2 Money Supply. 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. M2 is a measure of the money supply that includes cash, checking deposits, and easily convertible near money. 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. and in the process is giving huge amounts of free money to financial institutions. 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. Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors. It is still mind-boggling to me that the unprecedented growth of M2 has almost completely escaped the public's notice. That is what happened in the 1990s. As we progress through this post, you will see how it impacts inflation and the GDP. Put another way, the U.S. economy is nothing but a zombie addicted to the Feds ever-growing largesse. 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. Quarterly. Are you sure you want to remove this series from the graph? Copyright Broken Pie Chart Podcast. Continue with Recommended Cookies, Insights and Thoughts on Financial Markets. Inflation (CPI) in the U.S. is at a four-decade high, coming in at 8.3% year-over-year. The consent submitted will only be used for data processing originating from this website. This blog offers commentary, analysis and data from our economists and experts. 1956. Everything's Endogenous. EconLog. 2015. 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. 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. 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. Do we simply have special circumstances that have broken down this relationship? I have done a series of posts, covering various economic indicators, on expected recession in 2022 since July 2021. 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 . Federal Reserve Bank of St. Louis; In the U.S., the Feds dual mandate is to balance unemployment and inflation. If not cycling through transactions, where did all that newly minted money go? Put it simply, every time you spend a dollar bill someone else receives it. https://fred.stlouisfed.org/series/M2V, It is these latter which had, basically, sunk M2 more than thirty years ago as any sort of useful monetary guide. Federal Reserve Bank of St. Louis, Units: The left part of the chart, from 1965 1981, clearly shows that rising inflation (red line) came with higher M2 velocity (blue line). Not anymore. Consider M1, the narrowest component. The linked post was written on February 3, 2022, and unsurprisingly, the U.S. printed a negative 1.4% GDP read. Can site, link, or share provided podcast website listed and sourced. Please be sure to comment, debate and let me know where you think the dollar goes next. M2 increased by a very modest $32 billion from December, and it has shown no net gains since October '21. Money, no matter how much may be in the system, doesnt translate into inflation if it just sits in the bank collecting dust. As human beings and social creatures . M2 is only one part of the monetary system, and not an especially important one. ), the Fed has finally pivoted, albeit painfully slowly. retrieved from FRED, You need to read Dr. Philip George, "The Riddle of Money Finally Solved". What is the M2 money supply? money supply * velocity = nominal GDP. Oxford University Press. Predicting the bottom at this time would be foolhardy. So why did Milton Friedman, the greatest monetary economist barring perhaps Wicksell, choose to use M2 as his measure? Calculated as the ratio of quarterly nominal GDP to the quarterly average of M2 money stock. Is that really a big deal given 2020 record 25% growth followed by 2021 12% growth? 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 . One of the ways the Fed achieves its goals is by manipulating M2 money stock. The M2 for April 2022 is lower by $81.2 billion. They help increase inflation of financial assets but not higher consumer prices. A declining M2 constitutes deflation. 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. He specialized in analysis of Federal Reserve policy and interest rate forecasting, and spearheaded the firm's research into Treasury Inflation Protected Securities (TIPS). 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. These put persistent pressure on prices. Maybe there is a technical problem with the data source. 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. Essentially, this means that one USD cycled through the U.S. economy in Q4 2021 about 1.123 times. The money supplyis 100 for t = 0, 1. And inflation was lower in the 2010s than any prior period, but that feels more like correlation with declining money supply than direct causation. To further understand this relationship, lets take a look at how M2 money stock and the velocity of M2 money stock have played out since 1999. M2 Velocity is a . Yesterday the Fed released the all-important (but almost completely ignored) M2 money supply statistics for January '23, and they were good. In other words, MZM money is M2 money minus time deposits. Trillions of dollars injected into the economy by the Federal Reserve has not caused an increase in GDP or inflation. According to the Quantity Theory of Money, inflation depends on the money supply and its velocity. Low money velocity is usually associated with recessions and contractions. When there are more transactions being made throughout the economy, velocity increases, and the economy is likely to expand. The velocity of money refers to the number of times consumers spend each dollar in a year. Videos showing how the St. Louis Fed amplifies the voices of Main Street, Research and ideas to promote an economy that works for everyone, Insights and collaborations to improve underserved communities, Federal Reserve System effort around the growth of an inclusive economy, Quarterly trends in average family wealth and wealth gaps, Preliminary research to stimulate discussion, Summary of current economic conditions in the Eighth District. Lucas Jr, Robert E. Two Illustrations of the Quantity Theory of Money. The American Economic Review 70, no. High money velocity is usually associated with a healthy, expanding economy. When there are more transactions being made throughout the economy, velocity increases, and the economy is likely to expand. Or how that will alter inflation trends and they were good high coming! 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