Monday, November 3, 2014

Decomposing the velocity of money

We've received some questions about the ongoing declines in the velocity of money in spite of stronger US GDP growth in the past couple of quarters.

The velocity of money (as calculated by the Fed) is the ratio of quarterly nominal GDP to the quarterly average of money stock (M2 in this case). It's one of the measures used to assess how quickly money in circulation is used for purchasing goods and services.

The broad money stock growth in the US is currently quite close to its 30-year average of around 6% per year.

On the other hand, the nominal GDP gains in the US have been materially below historical averages. The ratio of Nominal GDP to M2 has therefore been declining.

However, with US inflation subdued, a relatively low nominal GDP increase has recently translated into decent real GDP results. Going forward, as long as inflation remains low, we could continue to see reasonable real GDP growth while the velocity of money remains depressed.

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