WHY A DECREASE IN US M1 MONEY VELOCITY LAST QUARTER WAS NEARLY CERTAIN, AND WHY FALLING MONEY VELOCITY IS IMPORTANT

What’s been happening to U.S. M1 money velocity lately?  Even before the U.S. Bureau of Economic Analysis announced recently that U.S. real GDP increased by four per cent in the fourth quarter of 2020, it was nearly certain that U.S. M1 velocity fell in the fourth quarter of last year.  At least a few factors led to that near certainty.  Using data from the St. Louis Fed’s FRED webpage, I calculated (from a quarterly average of seasonally adjusted monthly data) that U.S. M1 increased from 2020q3 to 2020q4 at an annualized rate of about 60%!  Because the velocity of a monetary aggregate equals nominal GDP divided by the money supply or the stock of that monetary aggregate (or velocity is real GDP times the price level divided by the money supply), nominal GDP would need to have increased at an annualized rate by at least 60% to have kept M1 velocity from falling in the fourth quarter of 2020.  An increase that large seemed very unlikely.

Further, some economic data suggested possible weakness in the U.S. economy in the fourth quarter of 2020, making a decline in money velocity at least somewhat more likely.  For example, recent information from the U.S. Census Bureau indicated that U.S. retail sales continued decreasing in December 2020.  Also, the U.S. Bureau of Labor Statistics announced a decrease in U.S. employment for December 2020 based on its establishment survey, although the household survey found a relatively small increase in employment.

In light of relatively rapid money supply growth, readers may want to note that money supply growth could be so important for determining whether money velocity is rising or falling (at least in the short term) that my 2015 book It’s Velocity, Stupid! (short title) discussed the possibility of an NDVMSL or an MCVMSL – a time-varying money supply level above which the velocity of that money stock would automatically fall.  (Note that NDVMSL stands for non-decreasing-velocity money supply level and MCVMSL represents maximum constant velocity money supply level.)

Moreover, how many have noticed that the U.S. M1 money supply has more than QUADRUPLED from December 2007 to December 2020 (based on my calculations using St. Louis Fed FRED data)? Where is all of the money going?  It certainly does not all seem to be going toward nominal GDP spending.  Otherwise, U.S. M1 velocity would not have plummeted so dramatically in a relatively short timespan.

Falling U.S. M1 velocity in this period raises questions.  Has relying on monetary policy been able to complete the recoveries from the Great Recession and the COVID-19 coronavirus economic collapse in the United States?  Is there a better way to stimulate the economy rather than essentially relying on expansionary monetary policy?  (I may have more to post about the previous two questions soon.)  Can strategic fiscal policy help by getting U.S. dollars to trade in GDP transactions and by providing relief to millions who have been suffering? Will the likely forthcoming additional stimulus be enough?

                                         

Please note that subsequent data revisions may change the above analysis, and note that the following websites were helpful in preparing this blog entry.

 

https://www.bea.gov/news/2021/gross-domestic-product-4th-quarter-and-year-2020-advance-estimate

https://fred.stlouisfed.org/data/M1SL.txt

https://www.census.gov/retail/marts/www/marts_current.pdf

https://www.bls.gov/news.release/archives/empsit_01082021.htm