Unfortunately real output is not fixed, and even at full employment, will fluctuate with the business cycles. The velocity of money is a measure of average number of times per year that a dollar is exchanged.
In order to make calculations easier it is often assumed that the velocity of money is constant. Critics, on the other hand, argue that in the short termthe velocity of money is highly variable, and prices are resistant to change, resulting in a weak and indirect link between money supply The constant velocity of money inflation.
Sincehowever, the velocity of money has fallen dramatically as the Federal Reserve greatly expanded its balance sheet in an effort to combat the global financial crisis and deflationary pressures. For example, an increase in the money supply should theoretically lead to a commensurate increase in prices because there is more money chasing the same level of goods and services in the economy.
If the economy is at full employment it can further be assumed that real output is fixed. M2 is M1 plus savings accounts, money market accounts, and smaller certificate of deposit accounts.
M1 shows how the velocity of money typically used for everyday purchases has changed. M1 is defined by the Federal Reserve as the sum of all currency held by the public and transaction deposits at depository institutions.
The velocity of money can be thought of as the turnover of the money supply. The "monetarists" who subscribe to the quantity theory of money argue that money velocity should be stable absent changing expectations, but a change in money supply can alter expectations and therefore money velocity and inflation.
Price level multiplied by output is the nominal output. On the other hand, M2 is the best representation of the money supply targeted by the Fed in its operations.
For this application, economists use broad measures of money supply: I had to decide whether to use M1 or M2 for the money supply. For example, from through the end ofthe velocity of M2 money stock averaged 1. As of the first quarter ofM2 velocity was just 1.
If this is true, any changes in the money supply would directly and proportionately change nominal GDP. I ended up calculating the data for both. To test the constancy of velocity I compiled data on nominal GDP and the money supply for the last forty years.
Therefore, a percent change in the money supply added to a percent change in the velocity is equal to a percent change in nominal output.
M1 is defined as currency in circulation plus demand deposits. For example, when the Fed sells treasury bonds on the open market this would theoretically reduce the M2 money supply because bonds are most likely paid for with money formerly held in saving and money market accounts.The quantity theory of money states that the money supply multiplied by the velocity of money is equal to the price level multiplied by output.
() Price level multiplied by output is the nominal output. Therefore, a percent change in the money supply added to a percent change in the velocity is equal to a percent change in nominal output.
(). In order to make calculations easier it is often assumed that the velocity. The Constant Velocity of Money. When estimating the effect of changes in the money supply to changes in nominal GDP, it is common to assume that the velocity of money is constant.
The velocity of money is a measure of average number of times per year that a dollar is exchanged/5(1). When estimating the effect of changes in the money supply to changes in nominal GDP, it is common to assume that the velocity of money is constant. The velocity of money is a measure of average number of times per year that a dollar is exchanged.
Empirically, data suggest that the velocity of money is indeed variable. Moreover, the relationship between money velocity and inflation is also variable.
For example, from through the end ofthe velocity of M2 money stock averaged x with a maximum of x in. The issue has to do with the velocity of money, which has never been constant, as can be seen in the figure below. If for some reason the money velocity declines rapidly during an expansionary monetary policy period, it can offset the increase in money supply and even lead to deflation instead of inflation.
The velocity of money is one of the most important economic concepts you can ever learn. It isn’t perfect, and it doesn’t fully capture vital influences on the way a nation’s money supply behaves as driven by behavioral economic considerations such as mass panic, fear, overoptimism, et cetra.Download