The Income Velocity of Money

The latest issue of The Economist argues that central banks should pay more attention to monetary aggregates in the conduct of monetary policy. Nevertheless, the Fed discontinued reporting M3 on March 23. In light of this, and for those who might be interested, here's a few graphs showing velocity and velocity growth measures based upon M1, M2, and M3, where V ≡ PY/M and PY is nominal GDP:

To decompose the velocity growth movements, recall that V ≡ PY/M. Then, in terms of percentage changes, %ΔV ≡ %ΔP + %ΔY - %ΔM where %ΔP is inflation, %ΔY is output growth, and %ΔM is money growth. For those that are interested, the components are shown in these graphs of real GDP growth, inflation, M1 growth, M2 growth, and M3 growth.

Comments

[PEmberton]

That decomposition of velocity is not technically
correct. The correct decomposition is transactions velocity. You are assuming a constant relationship between income and transactions. This false assumption is surely a good part of why it is hard to use monetary aggregates for policy purposes

[spencer]

I use MZM because the old money measurements no longer measure the same thing. If you look at MZM velocity== using personal income rather then gdp so I can do it monthly -- you get a great inverse relationship between velocity and real interest rates.

At some time years ago I also found a similiar inverse relationship between M 1 and real rates in the 1930s.

[Emmanuel]

Can America have Otmar Issing now that he's retiring instead of the free money enthusiasts it's had since Volcker?

Mr Issing was the architect of the ECB's monetary-policy strategy. He built it using a design taken from Germany's Bundesbank, where he was previously the chief economist. He holds two controversial beliefs that challenge prevailing monetary orthodoxy. First, he thinks that central banks must always keep a close eye on money-supply growth. Second, central banks sometimes need to lean against asset-price bubbles.

[EclectEcon]

What do these different trends mean? That people are getting their assets out of low-return M1 and M2 as fast as possible and into almost-as-liquid M3 balances and tending to leave them there longer? Makes sense to me.

[Erica]

Hi, I am taking an economics course online and I am having trouble with this section, so I have a few questions. What is the relationship between velocity and GDP? Also, in history, has there been a trend for M2 velocity? Thanks