IS THE MONEY SUPPLY GROWTH RATE IMPORTANT IN DETERMINING THE VELOCITY OF MONEY? AND WHY MAY IT BE IMPORTANT?

Data available at www.economagic.com suggest that the velocity of the U.S. M1 money stock started to increase again in the first quarter of 2018 after decreasing most quarters for roughly a decade.  As I pointed out in my book It’s Velocity, Stupid!  Is the Velocity of Money the Forgotten Variable of Macroeconomics? and in some of my earlier blog entries (and with others having made similar points if not the same point), whether the velocity of money increases, decreases, or remains unchanged depends on the relative percentage changes in nominal GDP and the money supply.  Why did velocity decrease?  The velocity of M1 in the U.S. continued to decrease for most quarters in the recovery from the Great Recession, at least until the first quarter of last year.  This occurred during those quarters because the percentage growth rate in the M1 money supply in the U.S. exceeded the percentage change in nominal GDP.  Why did this happen?

The quarterly average M1 money supply growth rate slowed down in the first quarter of 2018, again based on data from economagic.com.  Starting then, growth in nominal GDP spending in the U.S. outpaced the growth rate of the M1 money supply in the U.S., resulting in the velocity of the U.S. M1 money stock increasing.  Again, why did this happen?  Given that the percentage growth rate of the money supply helps to determine whether the velocity of money is increasing, decreasing, or staying the same, does the relatively recent change to increasing M1 velocity overstate what seems to at least some like improved performance of the U.S. economy?  Although a lot of the recent U.S. economic data may be good, CNBC and others reported that December 2018 retail sales fell (when measured on a seasonally adjusted basis) and that February 2019 total nonfarm payroll employment  increased much less than expected.  Further, CNBC has shown the five-year U.S. Treasury rate below the two-year U.S. Treasury rate most of the time since early December 2018.

I asked in It’s Velocity, Stupid! and in some of my earlier blog entries whether a time-varying non-decreasing-velocity money supply level or a maximum-constant-velocity money supply level (an NDVMSL or an MCVMSL) exists above which the velocity of money would automatically begin to decrease.  If such an MCVMSL or an NDVMSL exists, then the U.S. economy was below that money supply level in the year 2018, as evidenced by the growth of the M1 money supply.  

My calculations using data from the Saint Louis Federal Reserve web page and compiled by the U.S. Bureau of Economic Analysis find that the percentage nominal GDP growth rate from four quarters earlier was higher in 2018 than in 2017. Thus, that would contribute to rising money velocity.  However, in light of a slowdown in the growth rate of the U.S. M1 money supply, part of the reason is due to slower money supply growth.  Although nominal GDP spending is growing and perhaps more rapidly despite tighter monetary policy, could this be largely if not exclusively due to more expansionary fiscal policy?  If so, then what would happen to the economic growth rate if fiscal policy turned less expansionary?  But again, a lot of the recent U.S. economic data may be good.

 

We’ll have to see what the future brings.  Until then, we should make an effort not to be overly optimistic or overly pessimistic about economic conditions.