DID U.S. M1 VELOCITY START TO DECLINE AGAIN IN THE SECOND QUARTER OF 2019?

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.