Opinions expressed are those of the author. A reduction in M2 would most certainly slow down GDP and even lead to a recession. The Fed has seriously distorted money supply. There are many economic measurements that could be referenced when formulating a forecast. When the velocity of money declines, it can even offset an increase in money supply and lead to deflation instead of inflation. Expertise from Forbes Councils members, operated under license. 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). The M2 was $21.42 trillion in October 2022, as reported on Nov. 22, 2022. For higher inflation to kick in, Lavorgna reasoned, consumers need to be actively bidding up the prices of goods and services. 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. Consider M1, the narrowest component. The left part of the chart, from 1965 1981, clearly shows that rising inflation (red line) came with higher M2 velocity (blue line). Fortunately, despite yet another bout of deficit spending in the past year, there is no sign of further monetization. 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. Please enter your email address or username below. . Chart #1 is the main attraction. 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 personal saving rate is a primary indicator to track velocity of money and inflation. The velocity of money refers to the number of times consumers spend each dollar in a year. Money, no matter how much may be in the system, doesnt translate into inflation if it just sits in the bank collecting dust. 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. and in the process is giving huge amounts of free money to financial institutions. 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. GDP = M2 Money Stock * The Velocity of M2 Money Stock - (Eq. Barnett, William A. FRED Series Velocity of M2 Money Stock. In the U.S., the Feds dual mandate is to balance unemployment and inflation. By the end of that year, M2 totaled . 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. Not anymore. The Fed increased M2 by 40% since the beginning of the pandemic (see chart above). We dont yet know if or how that will alter inflation trends. The. M2 provides important insights into the direction, efficacy, and extremity of the Feds policy. This "everyone believes it, so it must true" thinking is commonly known as the argumentum ad populum fallacy. 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. Case 3 . Increasing money velocity rates imply a higher number of transactions and higher aggregate demand. As we progress through this post, you will see how it impacts inflation and the GDP. Federal Reserve Bank of St. Louis, You should consult with a licensed professional for advice concerning your specific situation. Please. 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 personal saving rate can be calculated as the ratio of personal savings to disposable personal income. Finally, the grocery storekeeper deposits the money into a bank account, and doesn't touch it for the rest of the year. A higher MV figure means a dollar is cycling through domestic transactions for goods and services more frequently. Conversely, a lower figure would mean the exact opposite, which could indicate a slowing economic backdrop. MacMillan and Company Limited. Learn more about the Econ Lowdown Teacher Portal and watch a tutorial on how to use our online learning resources. Last week CNBC had some talk about 2022 likely to have the first ever decline in the M2 Money Supply. You need to read Dr. Philip George, "The Riddle of Money Finally Solved". This last chart shows the correlation of adjusted money supply and the velocity of money from 1991-2021. Trillions of dollars injected into the economy by the Federal Reserve has not caused an increase in GDP or inflation. We and our partners use cookies to Store and/or access information on a device. Are labor supply and labor demand out of balance? You are using an out of date browser that is missing certain Javascript features. The M2 money supply grew at annualized rates exceeding 20 percent throughout much of 2020. Federal Reserve Bank of St. Louis, Units: Most surprising of all: how in the world could the Fed not see it? March 1, 2023. 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. Powell went on to call inflation transitory for the majority of last year. 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). Is there such a relationship in the first place? 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. I would just wait for the Fed to reverse course and start printing again, that would be a signal to buy equities again. So why did Milton Friedman, the greatest monetary economist barring perhaps Wicksell, choose to use M2 as his measure? No wholesale; no offshore. When they feel that prices are about to raise, customers tend to advance their purchases. Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors. A slower recovery is also a more long-lived recovery, one that can spread into 2022 and even 2023. Amazon Return To Office Mandate, And Whats Happening With Amazon Stock? Before May 2020, M2 consists of M1 plus (1) savings deposits (including money market deposit accounts); (2) small-denomination time deposits (time deposits in amounts of less than $100,000) less individual retirement account (IRA) and Keogh balances at depository institutions; and (3) balances in retail money market funds (MMFs) less IRA and The Federal Reserve might describe it as the turnover rate of a dollar through the U.S. economy. https://www.econlib.org/archives/2015/10/everythings_end.html. The Quantity Theory of Money A Restatement. In. Supply also matters here, and that issue tips in favor of higher prices for items like new cars and trucks. Such an unprecedented increase in money demand has slowed down the velocity of money, as the figure below shows. The total stock of M2 jumped from 70% of GDP to 90% and is now back to 84%. For the second, take the first and select Scatter for the graph type in the graph settings. The lower-inflation wheels have been set in motion. This suggests limited inflation risks from higher M2 balances. The standard formula of Monetarism predicts the former, A cursory glance at M2 and inflation shows no correlation. The former goes to new highs of 2.2x, but the latter remains contained. That is what happened in the 1990s. We see 3 things going on here: 1 highlighted above to see the way to derive GDP from M2 money stock and the velocity of the M2 money stock. Please, Is inflation always and everywhere a monetary phenomenon, or merely a, phenomenon? 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. First, lets rearrange the Eq. 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:. Calculated as the ratio of quarterly nominal GDP to the quarterly average of M2 money stock. 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. What is the M2 money supply? 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 can not be undone. Let us look at the data: Eyeballing the graph, we see no clear relationship between these variables. See why for yourself by starting a 2-week FREE trial below. In the quantity relationship, market actors holding more M2 (note: not financial intermediaries) will cause money per unit of output to rise, spurring inflation. Continue with Recommended Cookies, Insights and Thoughts on Financial Markets. 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. , published 1969. Then they can buy something else with it. 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. Data in this graph are copyrighted. This gives you the first graph. 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. 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. Low money velocity is usually associated with recessions and contractions. Therefore, a huge increase in the denominator naturally results in a lower figure without the same corresponding increase in GDP. 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. Or. Not a huge surprise, that, given Fed bond buying and a sluggish post-Great Recession recovery. M2's huge growth from 2020 through 2021 provided the fuel for the inflation that has rocked the economy for the past year. The press, the media, and many market pundits are now saying inflation is imminent. 2). 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 economy's strength or people's willingness to spend money. 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. M2 is a measure of the money supply that includes cash, checking deposits, and easily convertible near money. Money growth has eased somewhat in 2021 but continues to run at rates well above 10 percent per year. 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. 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. There's a couple issues with simply believing M2 = inflation. The standard formula of Monetarism predicts the former. 5 (1980): 10051014. M2 increase of 20% to GDP followed by 5 years of 5% inflation. 2016. One, M2 is partially endogenous to inflation (well, really NGDP). 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