NEARLY STAGNANT GDP ESTIMATES AND RAPID MONEY SUPPLY GROWTH CONTINUE THE ALARMING DECLINE IN THE VELOCITY OF MONEY (Originally from 2015)

(I believe the blog post below is from April 29, 2015.)



Earlier today, CNBC and likely others announced that the initial estimate for U.S. real GDP in the first quarter of 2015 increased only about 0.2 per cent (on a seasonally-adjusted annualized basis). Another announcement stated that the initial estimate for the implicit deflator declined by 0.1 per cent in the first quarter of this year. Taken together, these estimates imply that nominal GDP growth for the first quarter of 2015 was quite weak. (Readers should realize that these initial estimates may be revised later, so that the conclusions that we draw about the first quarter may change, particularly if the revisions are large.)

What about the velocity of the M1 money supply? Many have noted that by rearranging the equation of exchange, velocity can be calculated as V=(P*Y)/M, where P represents the price level (in this case the implicit deflator divided by 100), Y represents real GDP, and M represents the money supply. Nominal GDP is represented by (P*Y) in the numerator of the fraction. Combining nearly stagnant growth in nominal GDP with continued rapid growth in the money supply implies that velocity probably fell. Estimates from the web page of the St. Louis Federal Reserve show that the alarming descent of the velocity of M1 in the U.S. continued in the first quarter. In fact, the data show that the initial estimate for the velocity of M1 fell below six times per year – the lowest level since 1975, while the velocity of M2 fell to just above 1.50 times per year – a level not seen in the sample period beginning in 1959!

In an earlier blog entry (from March 14, 2015), I indicated that I expected that the velocity of M1 would probably fall again in the first quarter of 2015. Even before the initial GDP estimates became available, I became nearly certain that the velocity of M1 would continue to decline based on the estimated increase in the M1 money supply growth in the first quarter of 2015. Similarly, my forthcoming book notes that when the M1 money supply grew by at least a certain percentage in the U.S. starting in the year 1959, the velocity of M1 usually declined, although the calculations of the percentage increases in M1 in the book are averages assuming a constant percentage growth rate of the money supply in each quarter during a sub-sample period and do not reflect compounding. (I identify sub-sample periods in the book based on whether velocity was generally increasing or generally decreasing.) Return to my blog later for more information.