The curious case of low U.S. money velocity

From the Federal Reserve’s definition of Money Velocity and Money Supply,

Money Velocity

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. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. If the velocity of money is increasing, then more transactions are occurring between individuals in an economy.

The frequency of currency exchange can be used to determine the velocity of a given component of the money supply, providing some insight into whether consumers and businesses are saving or spending their 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.

Money Supply

M1 is the money supply of currency in circulation (notes and coins, traveler’s checks [non-bank issuers], demand deposits, and checkable deposits). A decreasing velocity of M1 might indicate fewer short- term consumption transactions are taking place. We can think of shorter- term transactions as consumption we might make on an everyday basis.

The broader M2 component includes M1 in addition to saving deposits, certificates of deposit (less than $100,000), and money market deposits for individuals. Comparing the velocities of M1 and M2 provides some insight into how quickly the economy is spending and how quickly it is saving.

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. The velocity of MZM helps determine how often financial assets are switching hands within the economy.


The Equation of Exchange


Money Supply (M) * Money Velocity (V) = Price level (P) * Real economic output (Q)

Alternatively, Money Supply * Money Velocity = Nominal GDP



M1 money stock is currently at $3.78 trillion (up from $1.39 trillion in Q2 2008)
M2 money stock is currently at $13.96 trillion (up from $7.67 trillion in Q2 2008)
MZM money stock is currently at $15.36 trillion (up from $8.73 trillion in Q2 2008)

M1 money velocity is currently at 5.48, almost the lowest on record
M2 money velocity is currently at 1.44, almost the lowest on record
MZM money velocity is currently at 1.31, almost the lowest on record

Years of QE has caused money supply to grow at an unprecedented pace and there is ample liquidity in the financial system.

One could claim individuals and businesses/private sector are hoarding money instead of spending it. Well on the individual or household side of things we know the savings rate is now close to record lows.

US Personal Saving Rate February 2018
Source: U.S. Bureau of Economic Analysis

We know banks in the U.S. currently hold close to $2 trillion in excess reserves with the Federal Reserve earning over $25 billion in 2017 (read more here). This means they are being conservative with lending money.

Excess Reserves of Depository Institutions
Excess Reserves of Depository Institutions; Source: Board of Governors of the Federal Reserve System (US)

Being conservative in lending means charge-off and delinquency rates remain close to record low levels (read more here).

US Charge Off rates all loans, All Commercial Banks
Source: Board of Governors of the Federal Reserve System (US)
US Deliquency rates all loans, All Commercial Banks
Source: Board of Governors of the Federal Reserve System (US)

What does all this mean

Firstly, the general inference that an increase in money velocity is indicative of a strong real economy and a decline in money velocity is an indication of a weak real economy is not true.

Money velocity has declined due to a massive increase in money supply.

Either banks are still being very conservative in lending or there isn’t genuinely much demand for new credit.

More money supply is required to fuel GDP growth with low levels of money velocity. [That equation: Money Supply * Money Velocity = Nominal GDP]

Money velocity is gradually beginning to increase and at the same time the U.S. government is pumping trillions into the economy to stimulate it further, either this must result in higher price levels (inflation) or significant increase in real economic output [Money Supply (M) * Money Velocity (V) = Price level (P) * Real economic output (Q)].

If price levels begin to increase significantly, then Federal Reserve will hike rates at every possible opportunity.

Federal Funds Target Range
Source: Board of Governors of the Federal Reserve System (US)

4 Replies to “The curious case of low U.S. money velocity”

  1. Gosh, you would have the feeling that since roughly 1980, all this money could be going to people who don’t spend it. Now who could that be? Well since 1980, all the money has gone to the top 1%, while the bottom 99% have seen wages flat or even fall slightly. Maybe a rich person will do something a bit different with an extra C note than a poor person. JFC, is this not obvious?

  2. Not measuring the money earned illegally by illegal immigrants
    that send billions out of the country. So the money sent out of
    the country could not be spent in the U S A and the velocity of
    money would be effected.

  3. Mr Fuller up there is exactly right.

    How does the Fed inject money? Well, it buys bonds or similar stuff from people and gives them money instead. Who are the “people” (or banks) that have these bonds? Not poor people. And when you were getting near 0% interest with your bonds, maybe along with even with a little credit risk, you might as well just hold the cash instead.

  4. Income velocity, VI, is a contrivance. Transactions velocity, money physically exchanging counterparties, is the principal economic driver. Vt has been compromised because of the impoundment and ensconcing of monetary savings (income not spent). All commercial bank held savings are unused and unspent, lost to both consumption and investment (because the DFIs always create new money whenever they lend/invests with the nonbank public).

    George Garvy: “Ideally, only balances subject to check or, even better, balances shown on checkbook stubs of depositors should be used to compute velocity rates.”

    This is analogous to Dr. Richard G. Anderson’s, Ph.D. Economics, Massachusetts Institute of Technology (the world’s leading guru on bank reserves) explanative: “legal reserves are driven by payments”, payments being “total checkable deposits”.

    See: Dr. Philip George (where a proportion of cash is commonly represented as { k }, a portion of nominal income), as in Alfred Marshall’s “cash balance” approach)

    “The velocity of money is a function of interest rates”

    “Changes in velocity have nothing to do with the speed at which money moves from hand to hand but are entirely the result of movements between demand deposits and other kinds of deposits.”

    “When the interest rate is zero the velocity of money will tend to zero. This is because there is no incentive to move their accumulated savings out of demand deposits.”

    “When interest rates go up, flows into savings and time deposits increase.”

    “Holding interest rates down does nothing to boost investment because the problem is falling consumption.”

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