Tuesday, May 26, 2020

Is the Velocity of Money Signalling That There Will Be No Price Inflation?

Despite the super-aggressive money printing by the Federal Reserve, I am beginning to see a number of economists, sympathetic to Chicago School monetary thinking, playing down the potential of a strong spike up in price inflation "because the velocity of money is falling."

First off, the concept of the velocity of money is, to put it mildly, a bit rough around the edges (SEE: Man, Economy, and State: With Power and Market by Murray Rothbard pp. 831-842).

But to allow this problem to pass for the moment, one has to then ask: Why wouldn't the velocity of money be declining now, given the lockdown?

It is not like there are vast sectors where money can be spent. Indeed, many of the areas that are currently open have sticky prices.

For example, under current conditions, even if new money is pumped into individuals' wallets, it won't mean that rents will necessarily be going up immediately. Rent prices are, especially under current conditions, very sticky.

If we have an economy that consists of, say,  rent payments and ice cream buying and ice cream buying is locked down, then it is very possible for the velocity to decline under a lockdown.

However that says nothing about price inflation once the restrictions on ice cream selling are lifted. If restrictions are removed and everyone goes back to buying ice cream and everyone has more Fed money in their pockets, then the money spent on ice cream could very well go up--and the price of ice cream.

Further, if at the same time, there are supply shocks where less ice cream is available in the market than before the lockdown, you could have price pressures from both more dollar demand and less supply.

I also hasten to point out that it is possible for prices to go up when the velocity is declining if enough new money is in the system.

Let us go back to our ice cream example, if we assume that the money supply has increased by 10%  and that the cost of an ice cream with cone before the lockdown/money pump was $3.00, then we can say that buyers could now pay $3.30 for an ice cream with cone to keep the same price-money supply ratio.

But it is entirely possible that consumers, in general, would only be willing to bid $3.05 for ice cream with cones. This would result in price inflation but also a decline in velocity.

In other words, if dollar bidding only uses a small fraction of a money supply expansion above previous dollar demand, then you would have a case of increasing prices plus falling velocity.



  1. I think the falling velocity only bolsters the international dollar market which artificially impacts price finding within the US which keeps the wheels from coming off the economy as it is.

    Reserve status allows the swamp to just do as it pleases until someone is audacious enough to supplant the king of the hill.

    The covid response just emboldens the Oligarchy to steel more of the world value.

  2. Ok. Can someone explain this money velocity shit and its origins? Much like 2% inflation is perfect. Wtf did this come from?

  3. Velocity of money uses GDP and M2 in the calculation, so it's weird of everyone to pick apart the M2 growth part of the equation, but not the GDP part. To me GDP is an insufficient method of calculating cash flow, which is what they are really after. Does the new M2 money get spent on investments, goods, and services or does it pay down debt. Paying down debt may help balance sheets, but does not drive price inflation and is deflationary according to dollar milkshake and other current theories saying deflation and not inflation is going to happen. They keep pointing towards velocity of money also, but the need a better metric to prove their point. Government spending can quickly ramp up to spend dollars, but consumers aren't in the market for infrastructure. To understand cash flow, need to see how many dollars are needed to service debts, not just a total debt number. Mortgage debt is a big number, but a much smaller number owed each year. Same principle for corporate bonds, but I never hear the deflationists give the 12 month debt servicing dollar requirements. Maybe the Fed knows that number and is already handling it. In which case, stagflation can occur because the new M2 will primarily go to goods, services, and investments. Maybe I'm thinking right about this...

  4. The last velocity figure was discontinued in Sept. 1996. At that time it was the FED's longest running time series, the G.6 Debit and Demand Deposit Turnover release. But economists didn't understand the series. It includes a lot of financial transactions, etc., but when you apply rates of change, you get equivalent GDP figures.