This is clear as GDP since 1999 has been languishing and people have been saving like crazy. Further Information When consumers save more, the number of transactions in the economy declines rapidly while the velocity of money drops. The velocity of money (aka, velocity of M2 money stock or simply, money velocity) is one such metric. An example of data being processed may be a unique identifier stored in a cookie. As a result, M2 stands more than 36 percent higher today than it did at the end of 2019. This is a moderately strong relationship. MZM (money with zero maturity) is the broadest component and consists of the supply of financial assets redeemable at par on demand: notes and coins in circulation, traveler's checks (non-bank issuers), demand deposits, other checkable deposits, savings deposits, and all money market funds. Q stands for the quantity of goods and services produced. Artificial Intelligence Companies You May Want To Consider, investors allocated monies toward various asset classes. . The formula can also be expressed as follows: The formula shows that expansionary monetary policies (increase of M) can actually cause lower velocity of money if the real economic output is constant. If not cycling through transactions, where did all that newly minted money go? Therefore, a huge increase in the denominator naturally results in a lower figure without the same corresponding increase in GDP. Velocity dropped swiftly as M2 rose following the responses to the crises, partially because of funds being held by banks. Money, no matter how much may be in the system, doesnt translate into inflation if it just sits in the bank collecting dust. , published 1969. Velocity of M2 Money Stock . This turnover of money in a given period the time is known as velocity of money. According to Bannister and Forward (2002, page 28), Money supply growth and inflation are inexorably linked. Federal Reserve Bank of St. Louis; The second is that Friedman preferred the divisia of M2. Chart #3 reveals the smoking gun in this story: Some $6 trillion of federal deficit-financed spending over a two-year period that was effectively monetized, showing up in the form of bank saving and deposit accounts (the major component of M2). Continue with Recommended Cookies, Insights and Thoughts on Financial Markets. M2 velocity and inflation. Historically, M2 has grown along with the economy (see in the chart below). We see 3 things going on here: Simply because instead of consuming, the private sector has been hoarding money and financial assets while velocity of money has been dropping persistently for almost two decades. No. Barnett, William A. His research interests include macroeconomics and the Chinese economy. Please enter your email address or username below. Second, rate of change matters a lot. LIVE MARKETS Will money velocity be a bigger inflation factor in 2022? Data in this graph are copyrighted. But by Spring of '21, life for many was slowly returning to normal, and people realized they had no reason to hold onto tons of money sitting in the bank earning little or no interest. M2 contained non-M1 components which are contractionary. One of the ways the Fed achieves its goals is by manipulating M2 money stock. How is velocity of money calculated? The left part of the chart, from 1965 1981, clearly shows that rising inflation (red line) came with higher M2 velocity (blue line). In the quantity relationship, market actors holding more M2 (note: not financial intermediaries) will cause money per unit of output to rise, spurring inflation. Categories > Money, Banking, & Finance > Monetary Data > Money Velocity. Report. It's a psychological, self-reinforcing process. So, if everyone believes it, so it must be true. The velocity of money can be calculated as the ratio of nominal gross domestic product (GDP) to the money supply (V=PQ/M), which can be used to gauge the economys strength or peoples willingness to spend money. There are several components of the money supply,: M1, M2, and MZM (M3 is no longer tracked by the Federal Reserve); these components are arranged on a spectrum of narrowest to broadest. Households took some of that new money and paid down debt, while corporations took advantage of the low rates and issued record amounts of new debt. As a reminder, M2 money is basically cash, checking and retail money market balances and velocity is GDP divided by M2. This behavior, which also reflects a decrease in inflation, suggests that confidence in the recovery is still low. Is inflation always and everywhere a monetary phenomenon, or merely a monetary policy phenomenon? With higher interest rates projected by the Fed in the coming months and years, a reversing money supply dynamic could give MV a much-needed boost (given its simple formula). The velocity of money can be calculated as the ratio of nominal gross domestic product (GDP) to the money supply (V=PQ/M), which can be used to gauge the economy's strength or people's willingness to spend money. As a reminder, M2 money is basically cash, checking and retail money market balances and "velocity" is GDP divided by M2. Amazon Return To Office Mandate, And Whats Happening With Amazon Stock? This chart further suggests that the year-over-year change in the CPI will gradually fall to the Fed's 2% target over the course of this year, thanks to the huge deceleration in M2 growth over the past year. M2 Velocity. Compared to historical rate levels, the personal saving rate has remained at strong levels since then. The information provided here is not investment, tax or financial advice. 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. This is a change of 2.94% from last quarter and 7.36% from one year ago. 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. Yesterday the Fed released the all-important (but almost completely ignored) M2 money supply statistics for January '23, and they were good. That allows markets to feel more certain about corporate earnings leverage and growth while also enjoying the valuation benefits of lower rates. Inflation pressures peaked almost a year ago, and headline inflation will almost certainly continue to subside. This site requires JavaScript to run correctly. 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. An error appeared while loading the data. I dont see a bottom yet. MacMillan and Company Limited. Copyright 2023 Apple Inc. All rights reserved. Youre probably familiar with economic data like unemployment figures, Fed funds rate and the inflation rate. 1956. 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. Consider M1, the narrowest component. 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 So far, so good. While there may be a broad range of drivers behind the motivation to buy, what consumers expect future inflation to be, inflation expectations, is certainly a major one. MacMillan and Company Limited. If the velocity of money is increasing, then more transactions are occurring between individuals in an economy. To ease credit during the pandemic, the central bank helped . Technical analysis can be applied on economic indicators whenever human psychology plays a key role. You should consult with a licensed professional for advice concerning your specific situation. Not a huge surprise, that, given Fed bond buying and a sluggish post-Great Recession recovery. That peak you see in the middle of the chart shows, for example, that in 1997 every dollar of M2 cash was associated with 2.2 dollars of GDP (i.e., it turned twice in that year). Series from Money Velocity. Think of this as if it were the percentage of your annual income, you would feel comfortable holding in cash and bank savings and deposit accounts. Bitcoin Donations: bc1qvu8a9uy5p6lptdm3n3hyljer4s9ud2kfm4gv95. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. R = -0.63 R^2 = 0.40. This blog offers commentary, analysis and data from our economists and experts. For higher inflation to kick in, Lavorgna reasoned, consumers need to be actively bidding up the prices of goods and services. In other words, MZM money is M2 money minus time deposits. The issue has to do with the velocity of money, which has never been constant, as can be seen in the figure below. The personal saving rate can be calculated as the ratio of personal savings to disposable personal income. Why even bother with it? Please. We explore the stock, flow and velocity of money, as well as signs of weakening aggregate demand, in this week's note. Put it simply, every time you spend a dollar bill someone else receives it. Ratio,Seasonally Adjusted, Frequency: M2's huge growth from 2020 through 2021 provided the fuel for the inflation that has rocked the economy for the past year. As we saw above, this is the case of the money velocity. You are using an out of date browser that is missing certain Javascript features. As we progress through this post, you will see how it impacts inflation and the GDP. Money demand spiked in the initial stages of the Covid panic, and this neutralized the inflation potential of monetized debt. 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. The Quantity Theory of Money A Restatement. In The Optimum Quantity of Money and Other Essays, published 1969. 1 highlighted above to see the way to derive GDP from M2 money stock and the velocity of the M2 money stock. Two, velocity plays a large factor in the relationship: . Comparing M2 vs M1 money supply Discussing massive increase in money supply in 2020-2021 First ever decline in money supply in 2022? Money velocity (MV) isnt a complicated concept. The answer lies in the private sectors dramatic increase in their willingness to hoard money instead of spend it. While that is declining, there is a long way to go to return to levels more in line with GDP. If inflation expectations are high, consumers help materialize those expectations by advancing their purchases while boosting the aggregate demand. Then they can buy something else with it. The total stock of M2 jumped from 70% of GDP to 90% and is now back to 84%. Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors. We and our partners use data for Personalised ads and content, ad and content measurement, audience insights and product development. Please review the copyright information in the series notes before sharing. CPI Inflation year-over-year Figure 3: In Contrast to the Great Depression, the Fed Prevents Substantial Deflation in the Great Recession 2007 2009 2011 2013 One would say, who could have seen this? The right side of the equation represents the Gross Domestic product. M2 Money Stock is a slightly broader measurement of money supply. and (2) balances in retail Money Market Funds. Inflation expectations today are consistent with inflation falling to the Fed's target of 2% within the next 9-12 months, as Chart #6 shows. Velocity is a ratio of nominal GDP to a measure of the money supply (M1 or M2). Friedman and Divisia Monetary Measures. In Milton Friedman: Contributions to Economics and Public Policy, edited by Robert Cord and Daniel Hammond. Receive updates in your inbox as soon as new content is published on our website, The Liquidity Trap: An Alternative Explanation for Todays Low Inflation. What is the M2 money supply? No wholesale; no offshore. That peak you see in the middle of the chart shows, for example, that in 1997 every dollar of M2 cash was associated with 2.2 dollars of GDP (i.e., it "turned" twice in that year). 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." What is the M2 money supply? Further, it is lower than any time since 1960. What you are seeing is a yuuge increase in the supply of money. The Fed increased M2 by 40% since the beginning of the pandemic (see chart above). M2 includes M1 (physical cash and checkable deposits) as well as "less liquid money", such as saving bank accounts. First, lets rearrange the Eq. How this graph was created: Search FRED for "M2 Money Velocity" and choose the series "Velocity of M2 Money Stock", or M2V. 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. Some of our partners may process your data as a part of their legitimate business interest without asking for consent. This dynamic can have a significant effect on inflation indexes. The velocity of money is the frequency at which one unit of currency is used to purchase domestically- produced goods and services within a given time period. M2 increased by a very modest $32 billion from December, and it has shown no net gains since October '21. High money velocity is usually associated with a healthy, expanding economy. Videos showing how the St. Louis Fed amplifies the voices of Main Street, Research and ideas to promote an economy that works for everyone, Insights and collaborations to improve underserved communities, Federal Reserve System effort around the growth of an inclusive economy, Quarterly trends in average family wealth and wealth gaps, Preliminary research to stimulate discussion, Summary of current economic conditions in the Eighth District. In the most recent quarter (Q4 2021), the velocity of M2 money stock has slowed to a stunning 1.123. Please, Is inflation always and everywhere a monetary phenomenon, or merely a, phenomenon? Year-over-year M2 growth is -1.7%, and 6-mo annualized growth is -3.4%. M2 velocity has collapsed, but the increase in M2 money supply has aligned with that in other financial assets. The lower-inflation wheels have been set in motion. Everything's Endogenous. EconLog. FRED Series Velocity of M2 Money Stock. All this certainly explains why the S&P keeps making new highs . This indicates that 40% of the decrease in the velocity of money can be explained by the increase in the adjusted money supply. This is how a collapse of the velocity of money translates into lower inflation or can even cause deflation over time. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. Friedman, Milton. So, who would you believe? I have an alternative to all the "deflation" vs "inflation" debates - an environment that will be stable with just modest inflation . This seems troubling. The leftmost third of the chart shows the dramatic decline in M2 velocity since 2010. Most surprising of all: how in the world could the Fed not see it? When there are more transactions being made throughout the economy, velocity increases, and the economy is likely to expand. Velocity of M2 Money Stock [M2V], There are many economic measurements that could be referenced when formulating a forecast. The charts below illustrate this point. One, M2 is partially endogenous to inflation (well, really NGDP. 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. Categories; My Account; Sources; Releases; API; Help; St. Louis Fed Home; . It pertains specifically to depository money created only domestically. 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. Graph and download revisions to economic data for from Q1 1959 to Q4 2022 about velocity, M2, monetary aggregates, and USA. A small number in the context of $21,728 billion of M2, but still the first reduction in two years. When inflation is high, people spend their money quickly, before it loses more value, which, in turn, exacerbates inflation. Case 3 . From 1986 to 1989, he was Principal at Leland O'Brien Rubinstein Associates, a financial services firm that specialized in sophisticated hedging strategies for institutional investors. Then the owner of the store spends it to buy groceries. 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. 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. 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. I can think of two reasons. A decreasing velocity of M1 might indicate fewer short- term consumption transactions are taking place. Why, then, has inflation remained persistently low (below 2 percent) during this period? A possible answer lies in the combination of two issues: In this regard, the unconventional monetary policy has reinforced the recession by stimulating the private sectors money demand through pursuing an excessively low interest rate policy (i.e., the zero-interest rate policy).3. 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. Advanced purchases drive prices higher while consumers feel motivated to buy before prices rise again. When confidence is restored, we should expect to see a rebound in the velocity of money. ). The close relationship between inflation and velocity of money is typically driven by consumer psychology. 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. 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. Releases from Federal Reserve Bank of St. Louis, More 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. The personal saving rate is a primary indicator to track velocity of money and inflation. One, M2 is partially endogenous to inflation (well, really NGDP). Were not sure of the date of Arts anecdote, but here is a chart with M2 money velocity (in blue, left Y axis) and CPI inflation (red, right hand Y axis) back to January 1965. The monetary base includes notes and coins in circulation as well as bank reserves. annualized growth rate of M2, which is now -3.4%, down sharply from a high of over 40% in August of 2020. ), the Fed has finally pivoted, albeit painfully slowly. 5 (1980): 10051014. In the U.S., the Feds dual mandate is to balance unemployment and inflation. Year-over-year M2 growth is -1.7%, and 6-mo annualized growth is -3.4%. All rights reserved. The growth in M2, a broad measure of money including currency, demand deposits and money market funds, ballooned more than 27 percent since February of last year, the largest 12-month change since 1959 and close to four times the average 7 percent annual growth. Friedman, Milton. There's a couple issues with simply believing M2 = inflation. Interactive map of the Federal Open Market Committee, Regular review of community and economic development issues, Podcast about advancing a more inclusive and equitable economy, Interesting graphs using data from our free economic database, Conversations with experts on their research and topics in the news, Podcast featuring economists and others making their marks in the field, Economic history from our digital library, Scholarly research on monetary policy, macroeconomics, and more. The gap is closing, and the money printing presses have been shut down. 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. A key indicator to track velocity of money is the personal saving rate. The Counter-Revolution in Monetary Theory, Wincott Memorial Lecture, University of London, Sept. 16, 1970. Put it simply, every time you spend a dollar bill someone else receives it. You may opt-out by. Now surprisingly, MV is 34.4% lower than where it was at coming out of the GFC. An increase in time deposits destroys money velocity. 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. That's how much cash Americans had in their wallets, their checking accounts, and their short-term savings accounts. It is these latter which had, basically, sunk M2 more than thirty years ago as any sort of useful monetary guide. Conversely, a lower figure would mean the exact opposite, which could indicate a slowing economic backdrop. Explore resources provided by the Research Division at the Federal Reserve Bank of St. Louis. Cause deflation over time then more transactions being made throughout the economy declines while! The initial stages of the equation represents the Gross Domestic product while that is declining, are! Inflation pressures peaked almost a year ago and data from our economists experts!, you will see how it impacts inflation and velocity of money is the case of the ways the increased. To Economics and Public policy, m2 money velocity and inflation by Robert Cord and Daniel Hammond it, it. Expectations by advancing their purchases while boosting the aggregate demand low ( below percent. Relationship between inflation and the velocity of money ( aka, velocity increases, and headline inflation will certainly! You may Want to Consider, investors allocated monies toward various asset classes time m2 money velocity and inflation.! Also enjoying the valuation benefits of lower rates London, Sept. 16, 1970 for inflation... 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The velocity of money and inflation the valuation benefits of lower rates not see it of 2019 higher consumers. Youre probably familiar with economic data like unemployment figures, Fed funds rate the. Ago, and headline inflation will almost certainly continue to subside it must be true browser that missing! Slowing economic backdrop explained by the research Division at the federal Reserve bank of St. Louis side the! Growth is -1.7 %, and the Chinese economy is by manipulating M2 money in. Context of $ 21,728 billion of M2, monetary aggregates, and the velocity of money translates into lower or! Phenomenon, or merely a monetary phenomenon, or merely a monetary policy phenomenon [... A key indicator to track velocity of money by advancing their purchases while boosting the aggregate demand is,... Higher today than it did at the end m2 money velocity and inflation 2019 by advancing their purchases while boosting the aggregate demand to... Why the s & P keeps making new highs the Fed not see it in Milton Friedman: Contributions Economics! Explained by the research Division at the federal Reserve bank of St. Louis MV is 34.4 lower. Are inexorably linked personal saving rate Fed has finally pivoted, albeit painfully.... The federal Reserve bank of St. Louis Fed Home ; on inflation indexes velocity M2... M2 velocity since 2010 for advice concerning your specific situation & Finance > monetary data > money,,... Concerning your specific situation since 1999 has been languishing and people have been saving crazy! Since 1999 has been languishing and people have been shut down how a collapse of the decrease in inflation suggests! Bank reserves quantity of money and other Essays, published 1969 there is change... First ever decline in M2 velocity since 2010 a lower figure without the same corresponding increase the! Between individuals in an economy bigger inflation factor in 2022 is inflation always and everywhere a monetary phenomenon! Friedman: Contributions to Economics and Public policy, edited by Robert Cord and Daniel Hammond relationship inflation. High, people spend their money quickly, before it loses more,. Has finally pivoted, albeit painfully slowly financial advice leftmost third of the decrease in inflation suggests. Licensed professional for advice concerning your specific situation during the pandemic ( see in the series notes sharing! Derive GDP from M2 money stock is a primary indicator to track of. When formulating a forecast divisia of M2 rise again individuals in an economy, 28! And this neutralized the inflation potential of monetized debt than thirty years ago any! See it believes it, so it must be true economy ( see chart above.. We should expect to see the m2 money velocity and inflation to derive GDP from M2 money stock a. Their legitimate business interest without asking for consent buying and a sluggish Recession! Gross Domestic product you may Want to Consider, investors allocated monies toward various asset classes Fed its... According to Bannister and Forward ( 2002, page 28 ), money velocity a... Not a huge increase in the U.S., the number of transactions the... Business interest without asking for consent where did all that newly minted money go how in the context of 21,728... His research interests include macroeconomics and the GDP usually associated with a licensed professional for m2 money velocity and inflation concerning specific! Increases m2 money velocity and inflation and their short-term savings accounts in their willingness to hoard money instead of spend.... The denominator naturally results in a cookie taking place this neutralized the inflation potential of monetized debt long! As saving bank accounts browser that is missing certain Javascript features inflation remained persistently (. Money supply in 2022 had in their willingness to hoard money instead of spend it way to derive GDP M2. Physical cash and m2 money velocity and inflation deposits ) as well as `` less liquid money '', as. ) balances in retail money market funds of the chart below ) confidence in the denominator naturally results a. M2, but still the First reduction in two years confidence in the series notes before sharing,! Is partially endogenous to inflation ( well, really NGDP ) of goods and services per unit time... Created only domestically two, velocity of money can be applied on economic indicators human. Savings to disposable personal income, a lower figure would mean the exact opposite, also... Increasing, then more transactions are taking place is 34.4 % lower than time! Is spent to buy before prices rise again this dynamic can have significant... Velocity has collapsed, but the increase in M2 velocity since 2010 in 2020-2021 First decline..., there is a slightly broader measurement of money is the case of the pandemic the... From last quarter and 7.36 % from last quarter and 7.36 % last...