IS THE VELOCITY OF U.S. M1 CONTINUING TO DECREASE? SEASONAL ADJUSTMENTS MAY BE THE KEY.

As we approach the year 2020, a year of elections in the United States including the presidential election, and as discussion will likely intensify about how much economic growth is benefiting or failing to benefit most people in the U.S., let’s consider whether the velocity of the M1 monetary aggregate in the U.S. is continuing to decrease in the fourth quarter of 2019.  Although I am not certain, my best guess is that when data are posted in late January of 2020, the data will indicate a decrease in U.S. M1 velocity in the fourth quarter of 2019.  What are some factors that led to my conclusion?

One extremely important factor is that velocity data are seasonally adjusted.  Economic activity usually (if not always) accelerates in the fourth quarter of a year due to the holiday shopping season.  Therefore, if velocity data were not seasonally adjusted, then they would likely show that money velocity, meaning the average number of times that a unit of currency traded per time period (in this case, per quarter but annualized) actually increased in the fourth quarter.  The thinking here is that with holiday shopping in the fourth quarter, people are more likely to spend U.S. dollars that they hold either as currency, coins, or as checking account deposits with no restrictions on the number of checks that can be written.  Those methods for holding ‘money’ comprise most of the U.S. M1 money stock.

However, because spending usually if not always increases in the fourth quarter, it could potentially be misleading to look at higher gross domestic product (GDP) spending in the fourth quarter of the year compared with the third quarter of the year and automatically conclude that the economy is performing much better than before, for example, in previous years.  All of the increase could be simply due to the normal increase in spending in the fourth quarter.  Thus, GDP data are usually reported on a seasonally adjusted basis so that people can make more meaningful comparisons.  The goal of the seasonal adjustment in this case is to take away the typical increase in spending in the fourth quarter to better gauge the health of the overall economy and its trajectory. 

For readers who may not be familiar, money velocity is calculated as a fraction of nominal GDP spending (or GDP measured in units of currency with time-varying buying power) divided by the measure of the money stock for which velocity is being calculated.  I am nearly certain that the nominal GDP spending used to calculate money velocity in the U.S. is seasonally adjusted.  I also think that the measure of the money stock used to calculate velocity is also seasonally adjusted.  If that is correct, then the component parts used to calculate velocity are seasonally adjusted.  Thus, although if there were not seasonal adjustments, the velocity of the M1 money supply in the U.S. may well increase in the fourth quarter of 2019 compared with the third quarter of 2019, the part of the likely increase in velocity that usually if not always occurs in the fourth quarter of a year sans seasonal adjustments is removed from the data.  In turn, seasonally adjusted U.S. M1 velocity may show a decrease in the fourth quarter of 2019.

As of this writing before the fourth quarter of 2019 has ended, I do not have access to all of the relevant U.S. M1 money stock data for the fourth quarter of 2019.  However, it appears that relatively rapid growth in the U.S. M1 monetary aggregate continued into mid-December of 2019, if not later, at least when considering seasonally adjusted data from the Saint Louis Federal Reserve Bank FRED web page accessed December 30, 2019.  In fact, my preliminary calculations show that U.S. M1 money stock growth in the fourth quarter of 2019 may wind up exceeding ten per cent on an annualized basis.  Thus, in order for U.S. M1 velocity to increase in the fourth quarter of 2019, the growth in nominal GDP spending on a seasonally adjusted, annualized basis will need to have increased by more than whatever the M1 money stock growth rate is in the fourth quarter of 2019, perhaps more than ten per cent annualized.  Presently, nominal GDP growth that high seems unlikely given that (1) I seem to recall CNBC reporting last week that a measure of holiday spending in the United States was estimated to have increased by less than four per cent compared with holiday spending in 2018, (2) seasonally adjusted, quarterly-measured (but annualized) real GDP growth has not reached a rate of five per cent since the third quarter of 2014 based on data from the Saint Louis Fed web page FRED, and (3) inflation in the U.S. has been relatively low.  If seasonally adjusted growth in nominal GDP spending fails to keep pace with the increase in the seasonally adjusted money supply in the U.S. that likely occurred in the fourth quarter of 2019, then U.S. M1 velocity will have decreased yet again.

Data from the Saint Louis Fed web page FRED can be used to show that the U.S. M1 money supply has clearly more than doubled since December 2007.  Given that U.S. money supply growth has been relatively high but reports suggest that income growth for many in the U.S. has been relatively low, who is getting the dollars newly added to the U.S. money supply?

The general decline in money velocity in the U.S. after the fourth quarter of 2007, essentially concurrent with the start of the Great Recession, calls into question the effectiveness of relying mostly on monetary policy to complete the recovery from the Great Recession and deliver relief for millions of people.  Strategic fiscal policies can help to complete the task.

(Readers should realize that subsequent data revisions could alter the analysis in this blog entry.)