U.S. MONEY VELOCITY STILL FALLING (Originally from 2015)

(I believe that the following blog post was from February 13, 2015.)





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With the release in late January 2015 of new U.S. real GDP estimates for the fourth quarter of 2014, the slower economic growth in the United States compared with the previous two quarters underscored an underemphasized fact – the velocity of money (meaning the average number of times (on an annualized basis) that each U.S. dollar is exchanged in GDP transactions) has continued its remarkable decline that began in the first quarter of 2008.  For those trying to understand why the recovery from the Great Recession has been taking so long, the decline in the velocity of money provides part of the explanation.

Consider the M1 measure of the money supply, which is the total of currency, coinage, funds in checking accounts without a maximum number of checks that can be written each month, and travelers’ checks not included in the aforementioned checking accounts. The velocity of M1 in the United States has now fallen from a peak (at least with data beginning in the first quarter of 1959) of about 10.67 times per year in the fourth quarter of 2007 to about 6.15 times per year in the fourth quarter of 2014, according to data from www.economagic.com and also available at the Saint Louis Federal Reserve web page (both of which also have real GDP data). (Please note that at least some of the data may be revised.) Although it will not have data through late 2014, my forthcoming book details the sharp drop in the velocity of the M1 money supply, now more than forty per cent after the peak in the fourth quarter of 2007, as well as past fluctuations in M1 velocity, starting with the year 1959.

This decline in velocity helps explain why the current economic recovery has been relatively sluggish. So what happened to the velocity of M1 in the U.S.? The short answer is that the Federal Reserve has made many more dollars available, but the dollars are not turning over very rapidly due to weak growth in aggregate demand. Although the expansionary monetary policy has probably helped to avoid an even more severe contraction and has probably helped the economic recovery, in my view the inability of the expansionary monetary policy to generate a larger increase in aggregate demand has been a factor holding the U.S. economic recovery back and has resulted in a sharp drop in the velocity of money. More explanation is in my book to be published soon.

Beyond the statistics, in my view this startling drop in the velocity of M1 has unfortunate real-world implications. Think of how many more wants could have been satisfied had the recovery from the Great Recession been faster. Tragically, the largely lackluster recovery has meant that many people have not been able to maintain living standards. A faster recovery and/or the prevention of such a severe recession could have meant more jobs sooner – and at higher wages and salaries. How much easier could it have been for people to feed their families, buy clothing, make car payments, and do other things had more jobs and higher pay been the result of a more robust recovery?

The fall of velocity, in my opinion, shows the need for expansionary fiscal policy to complete the recovery from the Great Recession. Check back for more information.