From budding trends to mature industries, Novem Group works hard to stay abreast of developing news. Here’s what caught our eyes this week:
Velocity of Money (continued from the April 23rd Reading List)
- What Does Money Velocity Tell Us about Low Inflation in the U.S.?
Continuing on with last week’s comments on the subject, we’re still working to better understand this phenomenon.
Velocity is the ratio of Nominal GDP to the Money Supply.
- So velocity won’t increase if Nominal GDP rises in tandem with Money Supply.
Macro Economics 101…
- Nominal GDP = C+I+G+(X-M) or GDP= Consumption + Business Investment + Government Spending + Net Exports
- Under normal circumstances, a rise in government spending is offset by a drop somewhere else because taxes go up or the government borrows the money by issuing bonds (thereby lowering consumption).
- But it’s not happening that way… Government spending is up but the Fed is financing this by growing the money supply… there isn’t a full offset in the above equation.
- Low interest rates depress the velocity of money
“for every 1 percentage point decrease in 10-year Treasury note interest rates, the velocity of the monetary base decreased 0.17 points”
- In the late 90’s the 10y was at about 5.5%. Today it’s at 1.6%. So all else equal velocity should be down by 0.68. Starting with the 2.2 of the late 90’s that suggests that velocity of about 1.5- basically where we were pre-COVID.
- In a test-tube this little relationship lines up nicely but I don’t see much correlation between the 10y (below) and velocity. Despite great periods of volatility in the 10y, velocity seems tightly range-bound until quite recently.
- “for every 1 percentage point decrease in 10-year Treasury note interest rates, the velocity of the monetary base decreased 0.17 points”
- Velocity is the ratio of Nominal GDP to the Money Supply.
One narrative I’m hearing is that velocity will rise back up to its historic range of 1.6-1.8 and when this happens, it will be highly inflationary.
- Is velocity mean-reverting or is there something structural behind this change?
- Is it possible that we’re barking up the wrong tree? In the 1970s, inflation was very high but the chart of velocity is steady.