Monday, November 26, 2012

The Velocity of Money

This four and one half minute video from Lauren Lyster on Capital Account sums up money velocity for the non-economist.

And to get a good look at the money velocity from the St. Louis Federal Reserve:

From the video and the chart above you can see that even as the money supply has massively expanded through Fed quantitative easing, that the velocity has dropped below 1, meaning there is no multiplier. One new dollar is producing less than one dollar of economic activity. Part of this is explained by the large banks holdings of cash the banks keep on deposit with the Fed as "excess reserves" rather than being lent to businesses and consumers. In addition, large corporations have been sitting on hoards of cash as they watch the US government battle over Cap-N-Trade, Obamacare and tax policy, all things that effect business decisions and have created uncertainty.

You may also recall from a previous post a similar concept of the money multiplier from new debt spending and why the $831 Billion stimulus failed. That multiplier was also less than one. Charles Biderman estimated it to be about .2 (point two). So for every dollar spent there was 20 cents of new economic activity.

From the perspective of the Fed, these lower multipliers are considered evidence of deflation and "justify"the massive printing of new dollars irregardless of their effect in other areas. The low multiplier also explains the relatively subdued levels of inflation (though real inflation is higher that what the CPI suggests).

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