Much attention is being given to whether
or not and, if so, by how much the Federal Open Market Committee (FOMC) of the
Federal Reserve Bank will lower its target range for the federal funds rate,
the interest rate that one bank charges on overnight loans to other banks. While not receiving as much attention but
still of some importance is what is happening with the velocity of the U.S. M1
money supply. While coins, currency, and
funds in checking accounts with unlimited check-writing privileges make the
overwhelming majority of the M1 monetary aggregate, velocity refers to the
average number of times that a unit of money, for example a U.S. dollar, trades
per time period in a transaction that counts toward gross domestic
product. After roughly a decade of the
velocity of the U.S. M1 money supply falling nearly every quarter during the
Great Recession and the Not-So-Great Recovery, U.S. M1 velocity started to
increase recently. However, we may soon
find that the modest recovery of M1 velocity has reversed course with the
initial estimates of U.S. nominal GDP, real GDP, and money velocity that will
probably be released soon.
Money velocity is a ratio of nominal GDP, or
real GDP multiplied by a measure of the price level (in this case, the implicit
deflator divided by 100), divided by a monetary aggregate. Not only may U.S. nominal GDP growth for the
second quarter possibly have slowed down in the second quarter of this year,
but the M1 money supply growth rate has probably increased. Simply put, slower growth in the numerator of
the velocity fraction combined with faster growth in the denominator could
result in a decrease in M1 velocity.
Using data from www.economagic.com, I
calculate that the seasonally adjusted U.S. M1 money supply grew at an annualized
rate of more than 5.6 per cent in the second quarter of 2019. That means that seasonally adjusted nominal
GDP would need to have increased at an annualized rate by at least that amount
to prevent the velocity of money from decreasing. By comparison, the U.S. M1 money supply
increased by less than two per cent at an annualized rate in the first quarter
of 2019. Hypothetically, even if real
GDP in the U.S. increased by about three per cent at an annualized rate and the
implicit deflator increased by about two per cent at an annualized rate, both
in the second quarter of 2019, then nominal GDP would have increased by only
about five per cent at an annualized rate last quarter. With the U.S. M1 money supply having increased
by more than 5.6 per cent at an annualized rate based on the most recent data,
that would imply a decrease in M1 velocity in the second quarter of 2019. Please note that data revisions could impact
U.S. M1 velocity calculations in the future.
Why is this important? One reason is that falling M1 velocity helps
to show that expansionary monetary policy alone may possibly be insufficient in
at least some cases to stimulate growth, at least in terms of meeting policymakers’
goals. Expansionary fiscal policies,
such as increasing government expenditures and reducing taxes, can help to
stimulate growth. Government purchases,
in particular, ensure that dollars exchange in transactions that are part of
GDP. Thus government purchases
contribute directly to money velocity.
If other expansionary fiscal policies such as increasing government
transfer payments and reducing taxes result in greater GDP spending, then those
policies would also contribute to velocity.
Another reason why decreasing money
velocity could be important is that it could be a sign that the economic
expansion of the last decade may be slowing down. Falling money velocity could indicate that
people are more hesitant than before to spend dollars toward GDP transactions. With at least part of the yield curve based
on U.S. Treasury interest rates having been inverted much of the time for more
than six months, that could indicate that a recession is on the horizon.
We will have to wait for the data to be
released to see if U.S. M1 velocity did in fact fall in the second quarter of
2019. My best guess as of this writing
is that U.S. M1 velocity decreased in the second quarter of 2019. I think that some of my previous blog entries
show that looking at the money supply growth rate can help to determine whether
the velocity of money is increasing or decreasing. But again, recall that subsequent data
revisions could alter the calculations.
Some questions remain. Given that my calculations based on data from
www.economagic.com find that U.S. M1 velocity fell by more than 48 per cent from
the fourth quarter of 2007 through the fourth quarter of 2017, why aren’t more
people paying attention to money velocity? Further, even if U.S. M1 velocity fell in the
second quarter of this year, then will the decrease be just one quarter or
longer-term? And if the FOMC reduces its
target for the federal funds rate, will that be sufficient to prevent a
recession?
Time will tell regarding the latter two
questions. In terms of the former, I
tried to call attention to the alarming drop in U.S. M1 velocity in my book, It’s Velocity, Stupid! (short
title). I also plan to discuss money
velocity in my forthcoming book.
