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?