Economics
Velocity of Money
The velocity of money refers to the rate at which money is exchanged in an economy. It measures how quickly money moves through the economy and is used to make purchases or investments. A higher velocity of money is generally associated with a healthier and more dynamic economy, as it indicates that money is being spent and circulated more frequently.
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5 Key excerpts on "Velocity of Money"
eBook - ePubInterest and Prices
A Study of the Causes Regulating the Value of Money
- Knut Wicksell(Author)
- 2011(Publication Date)
- Read & Co. Books(Publisher)
CHAPTER 6 THE VELOCITY OF CIRCULATION OF MONEY A. A Pure Cash Economy T HE subject of velocity of circulation, so important for a proper appreciation of monetary questions, is treated very scantily in most economic text-books. Even the best writers sometimes display a certain lack of conviction with regard to the true meaning and bearing of the conception. Thus we find J. S. Mill making the singular assertion 1 that “rapidity of circulation. . . must not 2 be understood to mean the number of purchases made by each piece of money in a given time. Time is not”, states Mill, “the thing to be considered. . . . The essential point is, not how often the same money changes hands in a given time, but how often it changes hands in order to perform a given amount of traffic”, and so on. 3 If Mill were taken literally the whole definition would end up as a mere tautology. For in order to discover how often a certain sum of money changes hands in effecting the sale and purchase of a given quantity of goods, it is necessary to know the average price of the goods in question, which is precisely the quantity for the determination of which the (amount and) velocity of circulation of money are to be utilised. In other words, velocity of circulation as defined by Mill could not be regarded as an independent factor in the determination of average price. The real purport of Mill’s somewhat obscure explanations is as follows: The commodity price level depends not only on the quantity of available money and its velocity of circulation (in the sense in which everywhere else Mill himself uses the term), but also on the quantity of goods which are exchanged in the appropriate interval of time with the aid of this quantity of money
eBook - ePub- A. Marijs, W. Hulleman, A. J. Marijs, Wim Hulleman, Ad Marijs(Authors)
- 2019(Publication Date)
- Routledge(Publisher)
The demand for active balances depends on the nominal value of the goods and services produced during a given period. This is the same as the quantity of goods and services produced (Q) multiplied by the average price of goods and services (P). If production increases, the number of transactions will increase, causing the demand for money to grow. If prices rise there will also be more money required to carry out the transactions because more money will be required for the same quantity of goods.Velocity of circulationAlthough the demand for money is dependent on the nominal value of production in an economy, it is not identical to that amount. During a given period, money can be used more than once to buy goods and services. This is expressed by the velocity of circulation (V). This variable indicates the number of times a year a given monetary unit is used to buy goods and services. The greater the velocity, the smaller the amount of money required.The velocity of circulation of money depends firstly on the level of technical advancement (for instance, developments in the field of electronic payments) and on payment habits. In an economy where wages are paid once a week, the velocity of circulation is greater than in an economy where wages are paid once a month. At a monthly pay rate, the money is dormant longer than at a weekly pay rate. This implies that in an economy where wages are paid monthly a larger amount of money is needed than in a similar economy where wages are paid weekly. The technical aspects of payment traffic and payment habits are not subject to short-term change. Some economists consequently assume that the velocity of circulation is constant in the short term.Test 7.7What effect would electronic payments have on the velocity of circulation and the money supply needed?The velocity of circulation is also dependent on the interest rate. As has already been mentioned in the previous section, the demand for idle balances is determined by the interest rate. If the interest rate is low, the income lost from holding an idle balance will also be low. The chances that the interest rate will rise in the near future are also greater at a low level of interest. Investors are likely to hold a relatively large proportion of their capital in the form of an idle balance. If there is a large idle balance, an important part of the money supply is not being used for the purchase of goods and services. This makes the velocity of circulation low. A low interest rate will therefore cause a low velocity of circulation and a high interest rate a high velocity of circulation. In Section 7.4
- Daniel S. Ahearn(Author)
- 2019(Publication Date)
- Columbia University Press(Publisher)
Treasury deposits. This concept is con-sistent with the usage of critics of the monetary policy discussed in this chapter and has the merit of focusing attention on GNP or national income, both of central significance to monetary policy. Other definitions of velocity may use different money flows—total money transactions as in Irving Fisher's concep-tion, or even the money income or expenditure of a specific industry or part of the economy as in computations of sector velocities—or may enlarge the money stock to include savings and time deposits, U.S. Treasury deposits, and even savings and loan shares. For a discussion of various concepts of velocity, see Seiden, Monetary Velocity in the United States, in Studies in the Quantity Theory of Money, ed. by Friedman, pp. 180-82, 234-51. 2 6 6 CONTROL OVER FINANCIAL VARIABLES suit of a change in the amount of money in people's hands, or as a result of a change in the rapidity with which the existing supply of money is spent. Thus the importance of income velocity for monetary policy is obvious. VIEWS ON VELOCITY Awareness of velocity of the money supply as an economic quan-tity dates from as far back as 1664. 2 The interchangeability of an increase in velocity and an increase in money supply in achieving a larger flow of expenditures was discussed in the eighteenth and early nineteenth centuries. 3 The literature on velocity, however, is full of disagreement on the relationship of movements in velocity to move-ments in money supply; on whether there is a secular trend in velocity and, if so, what it is; and on the nature of velocity itself. 4 It may be helpful, in assessing the recent arguments of those who have stressed velocity in their criticisms of monetary policy, to sketch in some of the diverse paths which thinking on velocity has taken over the years. There has hardly ever been agreement on just how velocity be-haves.
- Gang Yi(Author)
- 2019(Publication Date)
- Routledge(Publisher)
PART THREE The Demand for Money 8 The Velocity of Money During the first fourteen years of the Chinese economic reform (1979-1992), the real gross national product (GNP, deflated by the official price index) increased 231 percent. In 1992, the currency in circulation and the broad money were, respectively, about twenty times of that in 1978, whereas the official price index increased only 125 percent, and the free market price index went up 141 percent for the same period. According to the quantity theory of money, which assumes that the Velocity of Money is stable, the money supply growth rate above and beyond the GNP growth rate should be fully reflected by the increase in price level. However, in China, the inflation rates, measured by both official price index and free market price index, are much smaller than the difference between the money growth rate and the real GNP growth rate. In other words, the Velocity of Money was not constant in China. It was decreasing rapidly during the reform decade. The volume of money in circulation (relative to real GNP) has been getting larger and larger. This chapter defines the income Velocity of Money, discusses alternative theories that explain the excess money with the focus on the monetization hypothesis. 8.1 The Income Velocity of Money Let us start with the exchange equation: MV=Py (8.1) where M is nominal money supply, P is general price level measured by the official price index, y is real income measured by GNP, Vis income velocity and is calculated by V= Py/M (8.2) 101 102 The Velocity of Money Taking the natural log of equation (8.1) and then differentiating, we get . . . V+M=P+y (8.3) where all the dot notations in equation (8.3) represent the growth rate. During the reform period, the growth rate of money supply has been consistently greater than the sum of the growth rate of GNP and the infla-tion rate regardless of which measurement of money (MO, Ml, M2) is used.
eBook - ePub- Nicholas Eberstadt, Milton Friedman(Authors)
- 2017(Publication Date)
- Routledge(Publisher)
This distinction is sharpest and least ambiguous in a hypothetical society in which money consists exclusively of a purely fiduciary currency issued by a single money-creating authority at its discretion. The nominal number of units of money is then whatever amount this authority creates. Holders of money cannot alter this amount directly. But they can make the real amount of money anything that in the aggregate they want to. If they want to hold a relatively small real quantity of money, they will individually seek to reduce their nominal cash balances by increasing expenditures. This will not alter the nominal stock of money to be held—if some individuals succeed in reducing their nominal cash balances, it will only be by transferring them to others. But it will raise the flow of expenditures and hence money income and prices, and thereby reduce the real quantity of money to the desired level. Conversely, if they want to hold a relatively large real quantity of money, they will individually seek to increase their nominal cash balances. They cannot, in the aggregate, succeed in doing so. However, in the attempt, they will lower the nominal flow of expenditures, and hence money income and prices, and so raise the real quantity of money. Given the level of real income, the ratio of income to the stock of money, or income velocity, is uniquely determined by the real stock of money. Consequently, these comments apply also to income velocity. It, too, is determined by the holders of money, or, to put it differently, it is a reflection of their decisions about the real quantity of money that they desire to hold. We can therefore speak more or less interchangeably about decisions of holders of money to change their real stock of money or to change the ratio of the flow of income to the stock of money.The situation is more complicated for the monetary arrangements that actually prevailed over the period which our data cover. During part of the period, when the United States was on an effective gold standard, an attempt by holders of money to reduce their cash balances relative to the flow of income raised domestic prices, thereby discouraging exports and encouraging imports, and so tended to increase the outflow of gold or reduce its inflow. In addition, the rise in domestic prices raised, among other things, the cost of producing gold and hence discouraged gold production. Both effects operated to reduce the nominal supply of money. Conversely, an attempt by holders of money to increase their cash balances relative to the flow of income tended to increase the nominal supply of money through the same channels. These effects still occur but can be, and typically are, offset by Federal Reserve action.Throughout the period, more complicated reactions operated on the commercial banking system, sometimes in perverse fashion. For example, an attempt by holders of money to reduce cash balances relative to income tended to raise income and prices, thus promoting an expansionary atmosphere in which banks were generally willing to operate on a slenderer margin of liquidity. The result was an increase rather than a reduction in the nominal supply of money. Similarly, changes in the demand for money had effects on security prices and interest rates that affected the amount of money supplied by the banking system. And there were further effects on the actions of the Federal Reserve System for the period since 1914.
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