Velocity of Money

A few years ago, we had a pretty high velocity of money. That meant, as a nation, we spent our dollars pretty rapidly. We had a lot of financial activity, and it kept our economy scooting along at top speed.

Now, we have low velocity of money. That means we’re not spending like we used to. Our demand is really low, and we’re in a recession.

The USG is going to start printing lots and lots of money. Given our current velocity of money, that will help fend off deflation… if we’re lucky. Once our velocity of money picks up again with an uptick in demand, though, we could be looking at the possibility of almost instantaneous high inflation.

Ouch and ouch, in other words.

36 thoughts on “Velocity of Money

  1. Sagar Patel

    Trying to lower the velocity by printing more money isn’t such a good idea. Printing more money leads to an extremely high inflation because the price of the dollar is going lower and lower.

    Velocity of money is represented by an equation:

    (Money supply)*(Velocity) = (Price level)*(Quantity of output)
    So in order to increase the velocity of money again, we must decrease the money supply and increase the price level of our goods.

  2. Caitlin

    I’m confused… I thought that printing more money typically caused inflation. Why is the government printing even more?

  3. deanwebb Post author

    Sagar: You can’t do that. Velocity is already very low. It won’t change. PQ is also equal to GDP. Without increasing the money supply by vast amounts, MV is going to be small, which will mean bad things for PQ and then GDP… and then your prospects of finding a job upon graduation…

    Caitlin: Yes, typically, that’s right. Our current financial crisis is not typical. We need to avoid deflation, even at the risk of massive stagflation down the road.

  4. Chi Nguyen

    So basically, we don’t really want to be in a really high inflation nor a really low deflation, just somewhere in between. I saw this somewhere and it says that the supply of money goes up while the supply of goods go down. And the demand for money goes down while the demand for other goods go up. We can’t balance the supplies and the demands in this world!

  5. Chanel Wan

    I don’t think we could ever truly balance the world’s supply and demand. It is something that is just too great to handle.

    Sugar you just confused me even more…

  6. Emily Rohrer

    Here’s me daring to be stupid:
    If we’re just going to print money anyway, why are we bothering with loans? I know printing money causes inflation… But if we’re going to print “lots and lots” of it, why don’t we print all of it and save ourselves the cost of interest? I don’t get it. I’d rather avoid becoming China’s parking lot.
    Oh, and another stupid comment:
    We fend off deflation by creating money. So when spending improves, could we… destroy money? Or is that not possible?

  7. Katie Wilson

    Would it help at all if we all started spending more? I know people don’t want to right now, but surely the money they spent would sort of come back to them in the form of a better economy… or is the economy just too far gone for that to help? And what about really rich people who have plenty of money to spare? Why aren’t they trying to help out? Or are they?

  8. Nolan K

    Katie I think that’s the whole thing Mr. Webb told my class about how a rational individual’s actions aren’t necessarily the same as the public’s actions. It would be great if everyone would all the sudden just start spending again though.

  9. Shaun Jackson

    The rich population is too small to help bring up the economy. But the way the goverment gets back all the money is that when you pay the goverment for anything with cash it takes some of it and destroys it. I also think the banks also have a hand in returning the cash. What is stagflation?

  10. Hugo Espiritu

    Stagflation is basically a slump in economic activity along with inflation. This happened in the 70’s during Nixon’s term greatly in part by the Vietnam War and by Johnson’s Great Society spending, which gobbled tax dollars and didn’t replace them where it was needed.

  11. David Liou

    If we avoid deflation, then we will have massive stagflation so our economy will never rebound. So then its better to deal will deflation now than an economic slump in the near future forever.

  12. Chanel Wan

    If we were to spend more money as a whole nation, wouldn’t that actually eff us over more in the long run? Because people usually use credit cards to buy things such as clothing, food, and everyday type things. So, wouldn’t spending money that no one really has truly mess us up more? sure it helps fix the debt in a short run but what happens in 10 years after that? or even a year?

  13. Chanel Wan

    And dealing with deflation would be better than dealing with inflation but doesn’t both hurt the country? Sure deflation sounds alot better than inflation but isn’t there a catch to it like everything else in life? or am i just crazy?

  14. Nikkiah Guerra

    I don’t think you are crazy Chanel…I think this country has gotten in over it’s head. However, the country is in recession and could possibly go lower into a trough, but in time the economy will rise again. (EVEN IF that’s not in our life time!)
    I have found a website that can better describe the roller coaster of economy. http://www.commondreams.org/view/2009/09/14-10

  15. Katie Wilson

    If we actually spent real money that we actually have, instead of just using credit cards and creating more debt, AND if people were actually willing to start spending again, would that make a difference?
    No, you’re not crazy Chanel. They would both be bad for our economy, but I’m thinking maybe inflation would be worse in the long run than inflation? I’m not sure…

  16. Katie Wilson

    * inflation would be worse in the long run than deflation… sorry 🙂

  17. Emily S.

    I know being in a recession sucks, but really, its not like we are living in Mexico with no running water. So what if Mr. X looses his beach house? If Recessions are cyclical, then won’t it get better on its own?

  18. deanwebb Post author

    Things do eventually get better, but only after they get as bad as they can get.

    And deflation is far, far worse than inflation. For serious.

    Nikkiah’s link is really good. We tend to focus on only one collapse at a time.

  19. Brian Rockwell

    Rather than try to comprehend how difficult it will be to solve both our velocity of money and subsequent inflation problems, we should focus on what we can do right now. What we can do right now is spend money. Understandably, people are hesitant to do so; yet it is vital for the recovery of the economy.

  20. Raphael Yohannes

    What I really want to know is how well or bad off our economy will be depending on the outcome of all this money printing?

  21. Ali Aenehzodaee

    high inflation seems to be easier to recover from than hyper deflation. At least people could get out of debt rather than climbing more and more in debt.

  22. Tais Altunian

    So what im getting from all this is inflation is easier to handle than deflation…and we should all try to make the value of money get lower by spending more? and once we do save ourselves from a major deflation crisis we can worry about resolving the inflation problem. its just a never-ending cycle thats gonna keep stressing out the world!!

  23. David Liou

    When we ‘spend more’ we tend to not spend our own money, because either we don’t have any or we think that paying interest is better for the individual, but raking up debt will not help the economy if fact the economy will become worse. Speaking of which how is the national debt going to go away without the US dollar inflating to the point of worthlessness.

  24. Chanel Wan

    I think that we should just take away credit cards all together so the debt would go down/ the United States would actually have to start spending the money that they actually have.

  25. Hugo Espiritu

    Yeah but then those credit card CEO’s wouldn’t get their payment for their really nice foreign cars. Really though debt is necessary for a nation because without debt people ewouldn’t be able to spend as much since a lot of wealth is concentrated in the hands of few and the wealthy just hoard it.

  26. David Liou

    We shouldn’t take away credit cards all together, we should limit the number of cards an individual can have, so people won’t ‘have’ $40,000 to waste from credit cards. This way the credit card CEOs will still have money to buy not so nice foreign cars and at the same time consumers will accumulate less debt.

  27. Ali Aenehzodaee

    I would hope most people have learned a thing or two about fiscal responsibility and living within ones means. Like David said, with credits cards you’re spending money you really don’t have and
    therefore not contributing to help increase velocity of money.

    In the Oak Cliff area, locally run shops are implementing the 3 50 project. Basically, it encourages people to spend 50 dollars at three local and specialty shops a month. This is meant to lighten the burden on the backs of local store owners and create some very local economic activity, all while discouraging shopping at big corporate stores like Target. I think this is good because most people can afford to do this without going into debt.

  28. Katie Foster

    Alright, so how did our sudden change in spending velocity happen? (Would that mean we have a negative acceleration? 😛 ) I thought the economy went down after 9/11, and that’s understandable, but from what I understood, it was back on top a couple years later. What has caused this change in the last couple years? Why aren’t we spending money like we used to?

  29. Hugo Espiritu

    Katie: I think that it has to do with the people being scared of risking their money in the market since all the chaos has happened. There are two emotions that consumers in the market face, fear and greed. Right now we are still in fear concerning the market.

  30. Katie Wilson

    Credit cards are okay, it’s just that people need to be wiser about using them. If you spend money on your credit card, you should only spend as much as you can pay back with real money. They shouldn’t be used as a way to spend money you don’t have, they should only be used as a substitute for carrying around a ton of cash or in case of emergencies. Just sayin’.

  31. deanwebb Post author

    What brought the economy back up after 9/11 was a massive credit bubble, fueled by home equity loans.

    I don’t think we’ll be going back to that anytime soon.

  32. Matthew Wong

    If there is more flow of money, would the economy get better? Because now people are just saving and saving, and no money is spent.

  33. Hugo Espiritu

    Well Matthew a healthy economy is constantly moving money through its system. If everybody hoards it there is no money to spend and nothing gets done with the money, It just sits there and looks good. But what good is money if you don’t spend it.

  34. David Liou

    @ Kaite
    That’s why there are debit cards that people never use.

    Even if another bubble is created will people ‘jump onto the wagon’ after they’ve seen how bad it can get?

  35. Hugo Espiritu

    I’m pretty sure people will still jump onto the wagon because what motivates people to propogate these bubbles is greed and greed will always be around.

  36. deanwebb Post author

    The trick is that greed can be tempered by fear. If there’s enough fear out there, the next bubble won’t materialize.

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