MONEY VELOCITY - THE FORGOTTEN VARIABLE?

People will probably pay much attention to economic news this week (October 26, 2019 – November 2, 2019) such as (1) the upcoming Federal Open Market Committee (FOMC) decision about whether or not to adjust its targets for the federal funds rate and the discount rate, and (2) the initial estimate of U.S. real GDP growth for the third quarter of 2019.  I don’t expect people to pay much attention to what is happening to the velocity of the monetary aggregates in the United States, U.S. M1 and M2.  But in my opinion, they should pay more attention than they are currently paying to velocity.

Based on recent economic data, I expect that the initial estimates of velocity for both M1 and M2 in the U.S. will show that money velocity fell in the third quarter of this year.  What are some of the factors that contributed to a likely decrease in money velocity?  U.S. retail sales were estimated to have fallen in September, the last month of the third quarter of 2019, compared with their August 2019 level, according to the U.S. Census Bureau.  (https://www.census.gov/retail/marts/www/marts_current.pdf)  Also, new home sales decreased in September 2019 compared with August 2019, according to a release from the U.S. Census Bureau and the U.S. Department of Housing and Urban Development. (https://www.census.gov/construction/nrs/pdf/newressales.pdf)

(Please note that in subsequent months, the web pages listed above may have releases about the current or most recent month and not the month for the data related to this blog post.)

Perhaps most importantly, money supply growth has been accelerating.  Using data from FRED of the Saint Louis Federal Reserve web page (https://fred.stlouisfed.org/data/M1SL.txt) accessed October 28, 2019, I calculated that seasonally adjusted U.S. M1 grew at an annualized rate (with compounding) of nearly 7.5 per cent in the third quarter of 2019.  Further, data from FRED (https://fred.stlouisfed.org/data/M2SL.txt) show with my calculation that seasonally adjusted U.S. M2 grew at a rate of about 8.2 per cent on a compounded, annualized basis. The fact that money velocity is a ratio of nominal GDP spending divided by a monetary aggregate measure would force nominal GDP to have increased by a percentage at least as large as the percentage increase in a monetary aggregate to avoid a decrease in the velocity of that monetary aggregate.  At this point it seems, at least to me, possible but not very likely that the increase in U.S. nominal GDP, seasonally adjusted and annualized, for the third quarter of 2019 will be large enough to prevent a decrease in the velocity of these monetary aggregates.  Readers should realize that subsequent data revisions could affect any and all of the calculations in this blog post.

Focusing on M1 velocity for now, if data show that U.S. M1 velocity did fall in the third quarter of 2019, then that would make two consecutive quarters and three quarters out of the last four quarters of falling M1 velocity, after increasing for four consecutive quarters, based on my calculations from data available Monday, October 28, 2019 on the Saint Louis Fed FRED web page (https://fred.stlouisfed.org/data/M1V.txt).  This poses questions.  Would this mean a return to a period generally falling M1 velocity, an attribute of much of the Great Recession and the Not So Great Recovery?  How effective is recent expansionary monetary policy if money velocity falls most if not all quarters and real GDP growth fails to accelerate?  Has the expansionary monetary policy been effective in preventing the U.S. economy from going back into a recession?  Does falling money velocity indicate limitations of relying on expansionary monetary policy to stimulate real GDP growth? 

I may have more about money velocity soon.  Policymakers and others should remember money velocity and fiscal policy in an effort to improve macroeconomic performance.  Interested readers can refer to my 2015 book, It’s Velocity, Stupid! Is the Velocity of Money the Forgotten Variable of Macroeconomics?, for additional information about velocity.  (I am referring to myself when using the term ‘stupid.’)  They can also refer to some of my recent blog posts with links listed below for more about money velocity and/or recent economic conditions and developments.

https://harrisonhartman.blogspot.com/2019/10/the-importance-of-decreasing-us-money.html

https://harrisonhartman.blogspot.com/2019/09/a-balancing-act-fomcs-decision-to.html

https://harrisonhartman.blogspot.com/2019/07/did-us-m1-velocity-start-to-decline.html

THE IMPORTANCE OF DECREASING U.S. MONEY VELOCITY

Based on the most recent available estimates on economagic.com (with data that were likely compiled by the Federal Reserve and the U.S. Bureau of Economic Analysis), the velocities of both the U.S. M1 money supply and the U.S. M2 money supply decreased in the second quarter of 2019.  In fact, I calculate from that data that U.S. M2 velocity fell for three consecutive quarters and U.S. M1 velocity fell during two of the last three quarters, both starting with the fourth quarter of 2018.  (Subsequent data revisions may change the analysis.)  If the M1 and M2 monetary aggregates either continued to grow, remained unchanged, or decreased but remained above a certain level in the final days and weeks of September 2019, then it is likely that both U.S. M1 velocity and U.S. M2 velocity fell in the third quarter of this year.  Further, both of these velocity measures may decline in the just started fourth quarter of 2019.  Why is this important?

Many may feel like the U.S. economy has not fully recovered from the Great Recession.  With portions of the U.S. Treasury yield curve inverted, the United States may be heading for another recession in the near future.  Even if the U.S. avoids a recession, economic growth seems relatively low. 

Expansionary monetary policies such as increasing the money supply or the money supply growth rate and reducing the target for the federal funds rate could help to increase economic growth and total employment.  However, when money velocity is falling, each dollar is trading less often on an annualized (seasonally adjusted) basis for GDP goods than it traded before.  If the goal is to increase spending in the economy, then at a minimum a greater increase in the money supply may be required to reach a targeted spending increase, and that assumes the increase in the money supply doesn’t result in no change in total GDP spending (or possibly a decrease in nominal GDP spending).  In that case where there is no change in nominal GDP spending, a greater money supply winds up in effect driving down velocity as people in essence wind up holding the newly created U.S. dollars rather than spending them.

Given the relatively rapid increase in the M1 money stock in response to the Great Recession but the failure of U.S. nominal GDP spending to increase by a similar percentage, my book It’s Velocity, Stupid! (short title), discusses the possibility of a (time varying) NDVMSL or an MCVMSL, that is, a non-decreasing-velocity money supply level or a maximum-constant-velocity money supply level.  If the MCVMSL or the NDVMSL exists, then any addition to the money stock above that level will automatically result in a decrease in the velocity of that particular monetary aggregate.

If the NDVSML or the MCVMSL exists, then it may be at a money supply level less than the level where additional dollars or lower interest rates fail to increase spending by even one cent.  If the percentage increase in nominal GDP spending is less than the percentage increase in the money stock, then by the definition of the velocity of money, money velocity must fall.

Falling money velocity brings up the possibility that relying on expansionary monetary policy may not be able to achieve the desired spending increase.  When trying to stimulate real GDP, expansionary fiscal policy can also be used, including in situations where expansionary monetary policy loses its effectiveness.  Strategic fiscal policy measures could help to ensure that dollars trade for goods and services more frequently.  What will happen to U.S. money velocity in the current quarter, the fourth quarter of 2019, and the year 2020?