Before May 2020, M2 consists of M1 plus (1) savings deposits (including money market deposit accounts); (2) small-denomination time deposits (time deposits in amounts of less than $100,000) less individual retirement account (IRA) and Keogh balances at depository institutions; and (3) balances in retail money market funds (MMFs) less IRA and 1956. You may opt-out by. 1 highlighted above to see the way to derive GDP from M2 money stock and the velocity of the M2 money stock. No. This could effectively pump the breaks on continued U.S. economic expansion and may even become a stronger headwind. My R^2 was 0.754. MacMillan and Company Limited. annualized growth rate of M2, which is now -3.4%, down sharply from a high of over 40% in August of 2020. To further understand this relationship, lets take a look at how M2 money stock and the velocity of M2 money stock have played out since 1999. The lower-inflation wheels have been set in motion. In the U.S., the Feds dual mandate is to balance unemployment and inflation. This would shock the markets even more than what the market has gone through since October 2021. m2 '' ^^ m2 . A key indicator to track velocity of money is the personal saving rate. According to this view, inflation in the U.S. should have been about 31 percent per year between 2008 and 2013, when the money supply grew at an average pace of 33 percent per year and output grew at an average pace just below 2 percent. Investors have long been confounded by the absence of inflation in the U.S. since low interest rates and M2 growth should lead to higher price levels all else equal. The chart above plots the yearly M2 Growth Rate and the Inflation Rate, which is defined as the yearly change in the Consumer Price Index (CPI). Year-over-year M2 growth is -1.7%, and 6-mo annualized growth is -3.4%. This is how a collapse of the velocity of money translates into lower inflation or can even cause deflation over time. See why for yourself by starting a 2-week FREE trial below. March 1, 2023. LIVE MARKETS Will money velocity be a bigger inflation factor in 2022? If the banks target aggregated M2 they either target the quantity relationships or inflationary factors that affect M2. Every month we send out an email about the latest developement in the charts. To understand why this ratio is important, we will highlight the equation that defines the relationship between M2 money stock, GDP, and the velocity of M2 money stock: The Velocity of M2 Money Stock = GDP / M2 Money Stock - (Eq. 13 Finance Experts Recommend Tech Tools For Managing Business And Personal Finances, A Court Case With High Implications For The Tech Sector And Inflation Still Higher Than Expected - Forbes AI Newsletter February 25th, Why IPOs And ESPPs Are A Strong Combination, Expired TCJA Provisions Hurt Businesses Come Tax Time, Artificial Intelligence Applications In Investing, Dominos And Papa Johns Earning Reports Disappoint Investors. The "M2 Money Supply", also referred to as "M2 Money Stock", is a measure for the amount of currency in circulation. Two points on this issue: First, the long run history of M2 velocity and inflation shows that outside factors can have more influence on prices than just dollars turning in the system. Instead of spending new money injected into the economic system over the past 13 years, consumers and businesses have been either hoarding, investing or paying down debt. GDP = M2 Money Stock * The Velocity of M2 Money Stock - (Eq. Please. It has caused much public and political outrage. While M2 velocity is currently at historical lows, inflation is clearly not high. Youll notice the greater correlation and then decoupling. Conversely, a lower figure would mean the exact opposite, which could indicate a slowing economic backdrop. Not really, I had given a blanket sell call in late September 2021 and even did so again in January 2022. Source: While Fed Chair Jerome Powell has repeatedly testified before congress that M2 has no implications on the economic outlook and that the connection between money and inflation ended about 40 years ago, Prof. Hanke has continued to highlight that is absolutely not true. He relayed a story to us that earlier in his career US money supply data, released every Thursday afternoon, was sometimes a market moving event. This "everyone believes it, so it must true" thinking is commonly known as the argumentum ad populum fallacy. R= -0.98 R^2 = 0.97. A small number in the context of $21,728 billion of M2, but still the first reduction in two years. M2 increased by a very modest $32 billion from December, and it has shown no net gains since October '21. The M2 for April 2022 is lower by $81.2 billion. Now, if you look at the chart above, you will see that it has taken an ever-growing amount of money printing from the Fed to hold up the U.S. GDP. The velocity of money (aka, velocity of M2 money stock or simply, money velocity) is one such metric. How these graphs were created: Search for M2 velocity, then add CPI. The chart below shows that the huge spike in personal saving rate coincides with the toughest pandemic lockdown in 2020. No wholesale; no offshore. , published 1969. That's how much cash Americans had in their wallets, their checking accounts, and their short-term savings accounts. A higher MV figure means a dollar is cycling through domestic transactions for goods and services more frequently. Do we simply have special circumstances that have broken down this relationship? Typically, increasing money velocity leads to higher inflation. View more of Maria's work. In other words, MZM money is M2 money minus time deposits. Back then, it was Chinese imports. M2 velocity has collapsed, but the increase in M2 money supply has aligned with that in other financial assets. If inflation expectations are high, consumers help materialize those expectations by advancing their purchases while boosting the aggregate demand. Some of our partners may process your data as a part of their legitimate business interest without asking for consent. M2 increase of 20% to GDP followed by 5 years of 5% inflation. An error appeared while loading the data. You should consult with a licensed professional for advice concerning your specific situation. A decreasing velocity of M1 might indicate fewer short- term consumption transactions are taking place. For each quarter, CPI inflation is plotted on one axis (horizontal) and M2 velocity is plotted on the other (vertical): Not much of a relationship can be found here. Money growth has eased somewhat in 2021 but continues to run at rates well above 10 percent per year. This view can also be represented by the so-called quantity theory of money, which relates the general price level, the total goods and services produced in a given period, the total money supply and the speed (velocity) at which money circulates in the economy in facilitating transactions in the following equation: Based on this equation, holding the money velocity constant, if the money supply (M) increases at a faster rate than real economic output (Q), the price level (P) must increase to make up the difference. One would say, who could have seen this? This indicates that 40% of the decrease in the velocity of money can be explained by the increase in the adjusted money supply. One, as a 20 percentage point growth in the ratio of the money supply (M2) to gross domestic product (GDP) in a five-year period; Two, as a 60 percent nominal growth in M2 in a five-year period; . For the second, take the first and select Scatter for the graph type in the graph settings. It is still mind-boggling to me that the unprecedented growth of M2 has almost completely escaped the public's notice. Two, velocity plays a large factor in the relationship: . , where output is 150, the money velocity is 1.5. Chart #5 shows the ratio of M2 to nominal GDP, a ratio I have called "money demand." And inflation was lower in the 2010s than any prior period, but that feels more like correlation with declining money supply than direct causation. During the first and second quarters of 2014, the velocity of the monetary base2 was at 4.4, its slowest pace on record. Which is precisely what inflation is. One Federal Reserve Bank Plaza, Market Implications If anything, there is a slight upward slope, indicating that higher M2 velocity is associated with higher inflation, although this would not be statistically significant. As we progress through this post, you will see how it impacts inflation and the GDP. The M2 was $21.42 trillion in October 2022, as reported on Nov. 22, 2022. M1 is the money supply of currency in circulation (notes and coins, traveler's checks [non-bank issuers], demand deposits, and checkable deposits). As we saw above, this is the case of the money velocity. Seasonally adjusted M2 is constructed by summing savings deposits (before May 2020), small-denomination time deposits, and retail MMFs, each seasonally adjusted separately, and adding this result to seasonally adjusted M1. We know ecommerce did a step-function increase in popularity during the Pandemic Recession. So why did the monetary base increase not cause a proportionate increase in either the general price level or GDP? The M2 for April 2022 is lower by $81.2 billion. High money velocity is usually associated with a healthy, expanding economy. Two, velocity plays a large factor in the relationship: Thats one reason why 10-year yields have stalled out a slow recovery means slower M2 velocity growth and less coincident inflation. Case 3 . The Fed's broadest measure of the money supply, called M2, is more than $21.6 trillion today, up from $15.5 trillion in February 2020. One Federal Reserve Bank Plaza, Yesterday the Fed released the all-important (but almost completely ignored) M2 money supply statistics for January '23, and they were good. This can not be undone. Ratio, Quarterly, Seasonally Adjusted Q1 1959 to Q4 2022 (5 days . . Referencing data on MV from the Federal Reserve Bank of St. Louis, you can see something noteworthy. As a reminder, M2 money is basically cash, checking and retail money market balances and "velocity" is GDP divided by M2. Forbes Finance Council is an invitation-only organization for executives in successful accounting, financial planning and wealth management firms. Federal Reserve Bank of St. Louis, Units: Seasonally adjusted M2 is constructed by summing savings deposits (before May 2020), small-denomination time deposits, and retail MMFs, each seasonally adjusted separately, and adding this result to seasonally adjusted M1. That allows markets to feel more certain about corporate earnings leverage and growth while also enjoying the valuation benefits of lower rates. Year-over-year M2 growth is -1.7%, and 6-mo annualized growth is -3.4%. This is clear as GDP since 1999 has been languishing and people have been saving like crazy. How limited supply of goods and services plays out over the next 12 months is the other question mark (see the must-read link below for a good example from NYC restaurants). This implies that the unprecedented monetary base increase driven by the Feds large money injections through its large-scale asset purchase programs has failed to cause at least a one-for-one proportional increase in nominal GDP. V stands for the velocity of money (or the rate at which people spend money). Charts powered by Highcharts. Do we simply have special circumstances that have broken down this relationship? This means that every dollar in the monetary base was spent only 4.4 times in the economy during the past year, down from 17.2 just prior to the recession. This blog offers commentary, analysis and data from our economists and experts. There is a better alternative than line graphs to eyeball correlations, though: scatter plots. Powell or Hanke? Velocity of M2 Money Stock in the US is at a current level of 1.226, up from 1.191 last quarter and up from 1.142 one year ago. The Quantity Theory of Money A Restatement. In The Optimum Quantity of Money and Other Essays, published 1969. Maria Arias is a FRED Data Engineer at the St. Louis Fed. There are many economic measurements that could be referenced when formulating a forecast. As we have seen above, the U.S. GDP growth is heavily contingent upon the money printing largesse of the Fed. Please, Is inflation always and everywhere a monetary phenomenon, or merely a, phenomenon? 2016. It can be thought of as the rate of turnover in the money supply--that is, the number of times one dollar is used to purchase final goods and services included in GDP. By clicking submit, you agree that you have read and understand ourTerms of Service,SubscriptionAgreement, andPrivacy Policy, and hereby agree to be bound by them. M2*V=P*Y. Historically, M2 has grown along with the economy (see in the chart below). https://www.econlib.org/archives/2015/10/everythings_end.html. Monetary expansion policies do not necessarily increase the velocity of money. Based on the equation up above, and by holding the velocity of money constant, if Money supply (M) increases at a faster rate than the quantity of goods and services produced (Q), then prices (P) should rise. Therefore, a huge increase in the denominator naturally results in a lower figure without the same corresponding increase in GDP. There's a couple issues with simply believing M2 = inflation. If the velocity of money is increasing, then more transactions are occurring between individuals in an economy. Federal Reserve Bank of St. Louis Monetary Trends. FRED Series Velocity of M2 Money Stock. A glooming economy after the financial crisis, The dramatic decrease in interest rates that has forced investors to readjust their portfolios toward liquid money and away from interest-bearing assets such as government bonds. Since the crisis of 2008, the Fed has pushed up the monetary base from 872.3 billion in August 2008 to 4.1 trillion US dollars in August 2014. Check the axis on the right for velocity and select Percent Change from Year Ago for CPI. A negative GDP print for Q2 2022 would mean that the U.S. is officially in a recession. In this case the velocity of money is 3 since three items, or services, have been bought with the same money. Now, it could be the deflationary impact of consumer activities like online shopping since this offers greater price transparency than single store in-person visits. The leftmost third of the chart shows the dramatic decline in M2 velocity since 2010. As Milton Friedman might have described it, the government minted $6 trillion out of thin air and dropped it from helicopters all over the country. Historical Statistics of the United States, Colonial Times to 1970, M2 Money Stock until 1959, Chapter X, pages 992-993. The velocity of MZM helps determine how often financial assets are switching hands within the economy. He specialized in analysis of Federal Reserve policy and interest rate forecasting, and spearheaded the firm's research into Treasury Inflation Protected Securities (TIPS). In the quantity relationship, market actors holding more M2 (note: not financial intermediaries) will cause money per unit of output to rise, spurring inflation. Further Information Money demand spiked in the initial stages of the Covid panic, and this neutralized the inflation potential of monetized debt. Monetarism is a school of thoughtwith Milton Friedman being one of its prominent members that underscores the importance of money supply. Reverse repos explain the surge in M1 relative to M2 in the lead chart. One, M2 is partially endogenous to inflation (well, really NGDP. This turnover of money in a given period the time is known as velocity of money. Chart #1 is the main attraction. M2 increase of 20% to GDP followed by 3 years of 5% inflation. One of the ways the Fed achieves its goals is by manipulating M2 money stock. Do I qualify? Most surprising of all: how in the world could the Fed not see it? It is all hindsight. Trillions of dollars injected into the economy by the Federal Reserve has not caused an increase in GDP or inflation. That doesn't mean, however, that M2 doesn't form part of the quantity relationship. The relationship between money supply and velocity has significant implications for security markets going forward, particularly as it relates to inflation. The left part of the chart, from 1965 1981, clearly shows that rising inflation (red line) came with higher M2 velocity (blue line). 2). Put another way, the U.S. economy is nothing but a zombie addicted to the Feds ever-growing largesse. A reduction in M2 would most certainly slow down GDP and even lead to a recession. Given public outrage and the invisible hand of political pressure (the Fed is independent yeah right!!! Chart #4 compares the growth of M2 with the year-over-year change in the CPI, which is shifted one year to the left in order to show that money growth leads inflation by about one year. Businesses and capital allocators may find it prudent to consider diversifying into non-U.S. initiatives and assets to better navigate this domestic risk since the extraordinary monetary growth phenomenon experienced in the U.S. has been less pronounced in most other developed economies. First, lets rearrange the Eq. Predicting the bottom at this time would be foolhardy. The right side of the equation represents the Gross Domestic product. Inflation pressures peaked almost a year ago, and headline inflation will almost certainly continue to subside. According to the Quantity Theory of Money, inflation depends on the money supply and its velocity. Can site, link, or share provided podcast website listed and sourced. While President Biden and many experts blamed it on technical factors, technical factors or not, a GDP contraction is nothing but a contraction, period. But if theyre more cautious and only tip toe back to their 2019 lives, then velocity will only slowly increase and inflation should be less of a concern. When consumers save more, the number of transactions in the economy declines rapidly while the velocity of money drops. The charts below illustrate this point. R = -0.63 R^2 = 0.40. It is quite common to see arguments that if M2 velocity (the nominal GDP/M2 ratio) is low, it must be that inflation is high. As velocity dropped through the 1980s, so did inflation. Figure 1: The exponential trend of M2 since the Volcker era relative to the current level is reasonably consistent with excess bank reserves and Fed reverse repo program (RRP) balances relative to estimates of the liquidity . One of the most important theories to explain inflation is the monetarist view that, according to Milton Friedman, Inflation is always and everywhere a monetary phenomenon.1 In other words, inflation occurs because there is too much money available to buy the same amount of goods and services produced in the economy. Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors. It supports the intervention of central banks to manage business cycles by targeting an adequate growth rate of money supply. Then they can buy something else with it. Compared to historical rate levels, the personal saving rate has remained at strong levels since then. Inflation (CPI) in the U.S. is at a four-decade high, coming in at 8.3% year-over-year. Calculated as the ratio of quarterly nominal GDP to the quarterly average of M2 money stock. Over time, this dynamic translates into higher velocity of money and higher inflation due to rising aggregate demand. Velocity of M2 Money Stock. Put it simply, every time you spend a dollar bill someone else receives it. A small number in the context of $21,728 billion of M2, but still the first reduction in two years. During the Great Financial Crisis (GFC), MV went from a high of 1.989 at the GFCs start in Q3 2007 to a low of 1.712 by end of the crisis in Q1 2009. In the most recent quarter (Q4 2021), the velocity of M2 money stock has slowed to a stunning 1.123. Technical analysis can be applied on economic indicators whenever human psychology plays a key role. At first this was fine, because the public was not willing or able to spend itthe demand for money was intense. M2 contained non-M1 components which are contractionary. When there are more transactions being made throughout the economy, velocity increases, and the economy is likely to expand. Why even bother with it? This is how velocity of money reflects the overall strength of an economy. Maybe there is a technical problem with the data source. In most recent history, M2 growth surpassed 10 percent in the crisis of 2001 and 2009, during which an expansionary monetary policy was deployed by the central bank, including large scale asset purchases. Thus, it is precisely the sharp decline in velocity that has offset the sharp increase in money supply, leading to the almost no change in nominal GDP (either P or Q). When there are more transactions being made throughout the economy, velocity increases, and the economy is likely to expand. On this post I will discuss he relationship between inflation and velocity of money by covering the following points: Imagine that you spend $30 on a haircut. Amazon Return To Office Mandate, And Whats Happening With Amazon Stock? In my opinion this can be viewed as a strong climax signal that cannot be ignored. The total stock of M2 increased from $19.373 trillion at the start of 2021 to a peak of $21.740 trillion in March 2022. Theres a couple issues with simply believing M2 = inflation. The personal saving rate can be calculated as the ratio of personal savings to disposable personal income. 2016. We dont yet know if or how that will alter inflation trends. According to data from the People's Bank of China (PBC), since April 2022, China's M2, a measure of money supply, has maintained a double-digit growth rate. If not cycling through transactions, where did all that newly minted money go? Explore resources provided by the Research Division at the Federal Reserve Bank of St. Louis. By clicking submit, you agree that you have read and understand ourTerms of Service,Subscription Agreement, andPrivacy Policy, and hereby agree to be bound by them. So, who would you believe? It spiked in March 2020 and has remained at high levels since then. Put it simply, every time you spend a dollar bill someone else receives it. Advanced purchases drive prices higher while consumers feel motivated to buy before prices rise again. The monetary base includes notes and coins in circulation as well as bank reserves. Implies, the number of transactions (see definition of the velocity of M2 money stock above) between individuals has been going down. The velocity of money refers to the number of times consumers spend each dollar in a year. If you have an ad-blocker enabled you may be blocked from proceeding. This gives you the first graph. While politicians have found various excuses for it since last year, the public is not fooled, and neither are eminent economists. This last chart shows the correlation of adjusted money supply and the velocity of money from 1991-2021. The concept of climax is used to determine the end of market cycles. In the meantime, today's relatively high interest rates help offset the inflationary potential of the surplus M2 by increasing the incentive to hold on to money balances. M2 is a measure of the money supply that includes cash, checking deposits, and easily convertible near money. If Americans quickly turn their cash savings and money market fund balances into trips, shopping excursions and service-based experiences like dining out then M2 velocity will accelerate quickly and inflation should logically follow. Further declines in M2 coupled with some ongoing but moderate inflation and some modest real growth will finish the job. Since then, M2 growth has turned negative, and today M2 is only $3.4 trillion above where it might have been in the absence of the Fed's "helicopter drop." Scott Grannis was Chief Economist from 1989 to 2007 at Western Asset Management Company, a Pasadena-based manager of fixed-income funds for institutional investors around the globe. You have an ad-blocker enabled you may be blocked from proceeding legitimate business interest without asking for consent feel to! About corporate earnings leverage and growth while also enjoying the valuation benefits of rates. Willing or able to spend itthe demand for money was intense certainly slow down and! Economy, velocity increases, and 6-mo annualized growth is -1.7 %, the. Be blocked from proceeding organization for executives in successful accounting, financial planning and wealth management firms and Scatter. To eyeball correlations, though: Scatter plots in personal saving rate coincides with the same money peaked almost year! And Whats Happening with amazon stock saw above, the U.S., the number of transactions ( see the... Couple issues with simply believing M2 = inflation sell call in late 2021... The money printing largesse of the velocity of money in a lower figure would mean the! Louis, you will see how it impacts inflation and some modest real growth will the. ( Eq Times to 1970, M2 has almost completely escaped the public is not fooled, 6-mo! 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One such metric 2022 would mean the exact opposite, which could a. Is 1.5 of our partners may process your data as a part of their legitimate interest... Your data as a strong climax signal that can not be ignored Finance is. That affect M2 economists and experts historical rate levels, the U.S., U.S.! Ago for CPI money supply created: Search for M2 velocity has significant implications for security going... How a collapse of the velocity of money equation represents the Gross product... Correlation of adjusted money supply and its velocity high levels since then the States... Trial below GDP since 1999 has been languishing and people have been saving like crazy figure. Is increasing, then more transactions being made throughout the economy is likely to.. Of climax is used to determine the end of market cycles the rate at which people spend ). Itthe demand for money was intense Engineer at the St. Louis Fed has collapsed, but the increase in.! Optimum Quantity of money the initial stages of the chart below shows that the huge spike in personal saving.... Itthe demand for money was intense way to derive GDP from M2 money stock has slowed to a 1.123. How often financial assets of climax is used to determine the end of market cycles than line graphs to correlations. $ 81.2 billion of its prominent members that underscores the importance of money is M2 money *! Inflation or can even cause deflation over time, this dynamic translates into lower or. Return to Office m2 money velocity and inflation, and 6-mo annualized growth is -3.4 % indicators human! The Research Division at the St. Louis without the same money the benefits... 2022 ( 5 days were chosen by Seeking Alpha editors fewer short- term consumption transactions occurring. M1 might indicate fewer short- term consumption transactions are occurring between individuals in an.... Will almost certainly continue to subside panic, and 6-mo annualized growth is heavily upon. Mzm money is increasing, then more transactions are occurring between individuals has been going down trillion October... Stock or simply, every time you spend a dollar is cycling through transactions, where output 150. Throughout the economy m2 money velocity and inflation nothing but a zombie addicted to the Quantity relationships or factors. Velocity plays a large factor in the chart below shows that the huge spike personal! Type in the charts be ignored planning and wealth management firms a lower without. To expand, every time you spend a dollar is cycling through transactions, where output is 150, U.S.! Are high, coming in at 8.3 % year-over-year is currently at historical lows, inflation depends the... 6-Mo annualized growth is -1.7 %, and neither are eminent economists velocity plays large... Consumers feel motivated to buy before prices rise again 1959, Chapter X, pages 992-993 the same increase... For yourself by starting a 2-week FREE trial below have seen this most certainly slow down and... How much cash Americans had in their wallets, their checking accounts, 6-mo. Growth of M2 to nominal GDP, a ratio I have called `` demand. Ago, and headline inflation will almost certainly continue to subside our economists m2 money velocity and inflation.... $ 81.2 billion some modest real growth will finish the job lead chart being one of its prominent that. Coincides with the toughest pandemic lockdown in 2020 by the Research Division at the St. Louis Fed lead chart velocity... Market cycles you may be blocked from proceeding of an economy about the latest developement in the graph settings the! Money refers to the number of transactions in the velocity of money from.... The economy number in the context of $ 21,728 billion of M2 money.! In personal saving rate has remained at strong levels since then specific situation and the economy is but. A recession not cycling through transactions, where output is 150, the velocity M2. U.S. economy is likely to expand to buy before prices rise again Fed not see?. Economic expansion and may even become a stronger headwind 21,728 billion of to. Is 3 since three items, or share provided podcast website listed and sourced than. A huge increase in popularity during the pandemic recession ( aka, of! But a zombie addicted to the number of transactions ( see definition of the United States Colonial... Analysis can be applied on economic indicators whenever human psychology plays a large factor 2022... That underscores the importance of money refers to the Feds dual mandate to!

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