The housing crash, banking crisis and recession caused a sharp drop in the velocity of money.
Further, the velocity of money, how rapidly people use money, has been declining as well.
When the economy takes a cold shower, the velocity of money slows to a crawl.
However there is plenty of evidence that the velocity of money does drop, especially during a recession.
As a result, normal day-to-day short-term loan transactions ceased and the velocity of money went to zero.
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The volume and velocity of money is a reflection of economic activity, not the cause of it.
When the velocity of money turns up and meets a higher supply we have the potential for inflation.
The two charts to watch are that of M2 money supply and more importantly the velocity of money.
The velocity of money is falling at the same time money growth has come to an abrupt stop.
The result was a large increase in the velocity of money and hyperinflation.
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As the velocity of money picks up, the Fed will need to contract the monetary base to prevent rapid inflation.
When the money supply is falling in tandem with a slowing velocity of money, that brings up serious deflationary issues.
If M changed, for example, what might or might not happen to V the income velocity of money and why might V change?
When the velocity of money decreases (spending declines), profits are squeezed, and since companies rely heavily on profits, stock prices suffer.
Just like recognizing how new equilibriums can alter the dynamics of an environment, government policies can significantly change the velocity of money.
Not the least of which revolves around the velocity of money and how that changes as wealth moves between different economic classes.
If V (the income velocity of money which reflects the demand for money) is fairly steady, then M (money) growth should be 4%.
Third, while the Federal Reserve has indeed increased the money stock that it has control over (M0), the actual goal is to increase the velocity of money.
Then, as banks redirect the capital previously employed in the carry trade into commercial loans, economic growth will increase, but the velocity of money will also rise.
They start businesses and buy foreclosures and speed the velocity of money around the economy with a gush of pent-up desire to consume after years in the desert.
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It will also have little effect on the velocity of money, which should actually increase even more as the increase in interest rates fuels even more inflation angst.
The Fed has little or no influence on the velocity of money short of raising short-term interest rates to a level that causes an economic slowdown or recession.
In addition, higher short-term interest rates increase the opportunity cost of holding currency and checking accounts, and therefore will lead to an increase in the turnover or velocity of money.
If V (velocity of money), which is a reflection of the demand to hold money balances, is stable, then the growth in M should match the potential growth in Q.
Every way I looked at it the velocity of money was anything but stable and the volume of goods and services produced went up and down on the basis of what the expectations were of the future.
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Interest rates can be lowered to zero and money can be printed ad nauseum, but if excessive debt within the system is restraining private demand, the decline in the velocity of money will offset the benefit of the additional supply of dollars.
One tool the Fed has created in recent years has the goal of slowing down the economy and slowing down the velocity of money should the economy all of sudden take off due to all the stimulus the Fed has put into the system.
Likewise, if the velocity of outstanding money picks up substantially, a similar offset may be needed.
While the M0 money stock has indeed increased, inflation is up slightly, and banks are flush with capital to be loaned, the M3 stock of money is actually down (a much broader measure of money), the velocity of M3 is down, and banks have not been loaning out much money.
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