WHAT DOES FALLING MONEY VELOCITY MEAN?

(This blog post builds on my previous blog post from May 2, 2020 available at: https://harrisonhartman.blogspot.com/2020/05/does-falling-money-velocity-offer.html)

With everything that has been happening, it may well be understandable that little attention has been paid to the alarming decrease in the velocity of the U.S. M1 money supply. However, a greater focus on money velocity could offer valuable guidance to stabilization policy efforts to combat the COVID-19 coronavirus-related recession and the general growth slowdown.

If I remember correctly, then the velocity of the U.S. M1 money stock has fallen by more than fifty per cent compared with its peak in the fourth quarter of 2007, based on the most recent estimates from the FRED web page of the St. Louis Federal Reserve. Readers should realize that these estimates do not include the velocity of U.S. M1 for the second quarter of 2020. For that quarter, data when announced will probably reveal that M1 velocity fell again in the second quarter of 2020, and it probably fell sharply. Again, this likely 2020q2 decrease comes after U.S. M1 velocity lost more than half of its value from its 2007q4 peak. U.S. M2 velocity probably also fell last quarter. 

On one level, the reason for the decrease in U.S. M1 velocity is definition and simple arithmetic. The U.S. M1 money stock likely grew at an extremely rapid rate, at least for the U.S., in the second quarter of 2020. Expansionary monetary policy to stimulate economic growth explains or at least helps to explain the rapid money supply growth. Further, data to be announced will probably reveal that U.S. nominal GDP spending, meaning spending on the goods and services that are part of GDP measured at current prices, fell again in the second quarter of 2020. By the algebraic definition of the velocity of money (where the velocity of a monetary aggregate equals nominal GDP (real GDP times a price level) divided by that monetary aggregate), if the growth rate of the money stock exceeds the growth in nominal GDP spending, then the velocity of money must fall.

But, is there a deeper message that we should take from plummeting money velocity? When money velocity falls, each unit of currency (for example, each U.S. dollar) is trading on average less often than it did before in GDP transactions. If we have rapid money supply growth but rapidly plunging money velocity, are we ‘throwing money’ at the problem? Clearly, we will need to spend funds to try to combat the COVID-19 coronavirus and the economic recession. However, if the U.S. and other countries rely on expansionary monetary policy WITHOUT more expansionary fiscal policy, then are we in essence ‘throwing money’ at problems and hoping that things will work out? The combination of rapid increases in a monetary aggregate and plummeting velocity for that monetary aggregate illustrates that people who hold money balances do not necessarily plan on spending at least some of that money any time soon.

Strategically targeted expansionary fiscal policy can be used to ensure that dollars and units of other currencies trade in GDP transactions. After rapid increases in the money supply, the U.S. may have a sufficient number of U.S. dollars. Further, if one takes a modern money theory perspective as in L. Randall Wray’s (2015, second edition) Modern Money Theory (short title) and Stephanie Kelton’s (2020) The Deficit Myth (short title), then because the U.S. is a currency issuer where the U.S. dollar is not directly tied to another currency or a commodity and because U.S. federal debt is overwhelmingly if not exclusively denominated in U.S. dollars, the U.S. federal government cannot run out of U.S. dollars and can afford to buy any good or service that is for sale in the United States. Now is the time to use fiscal policies such as tax reductions and increases in government expenditures to ensure that U.S. dollars trade more frequently in U.S. real GDP transactions.

Some may be concerned about inflation becoming a problem in the near future in the United States if the U.S. continues to pursue expansionary fiscal policy and expansionary monetary policy. A concept in my book, It’s Velocity, Stupid! (short title), may help to address when inflation will more likely become a problem. The concept is the non-decreasing-velocity money supply level or the maximum constant velocity money supply level (the NDVMSL or the MCVMSL). If such a money supply level exists, then it is the greatest money supply level consistent with no decrease in the velocity of money from the previous quarter. In other words, if the money supply level increases above the MCVMSL or the NDVMSL, then the velocity of money must decrease.

Given that the velocity of money in the U.S. has decreased most quarters after the fourth quarter of 2007, the last quarter before real GDP started falling in the Great Recession, if an NDVMSL or and MCVMSL exists, then the money supply most quarters has exceeded the NDVMSL or the MCVMSL in those quarters, resulting in the velocity of money decreasing. Inflation has been rather muted in the U.S. since the start of the Great Recession if not longer. In light of the fact that the M1 money stock in the U.S. has more than tripled since December 2007 based on data from the St. Louis Fed’s FRED web page, velocity and the NDVMSL (or MCVMSL) may provide clues about when inflation is more likely to become a significant problem. More specifically, if money velocity continues to fall, then does that suggest that inflation is not likely to rise by much, if at all, in the short term? Does that further imply that policymakers can continue to use expansionary fiscal and monetary policies to stimulate growth without the need to worry about a significant increase in inflation in the short term, at least until money velocity either rises or stabilizes? When velocity starts to rise again in the future, does that mean that inflation will also likely rise in the future? Does the failure to this point of rapid money supply growth to stimulate rapid inflation in the U.S. provide insights into what causes inflation?

Again, the U.S. needs more expansionary fiscal policies to try to increase economic growth and recover from the COVID-19-related recession (and perhaps other recessions). Providing additional disposable income to consumers and businesses likely to increase spending would probably be extremely helpful.