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Below is a chart and brief excerpt from today’s Market Situation Report written by Tier 1 Alpha. If you’re interested in learning more about the Hedgeye-Tier 1 Alpha partnership, there’s more information here. |
According to the St. Louis Federal Reserve, the velocity of money measures the rate at which money circulates through an economy, essentially tracking how frequently a dollar is used to purchase domestically produced goods and services over a specific period. A rising velocity indicates that more economic transactions are taking place. While Monetarists will focus on money supply as the key driver of inflation (the proverbial M in MV=PQ), the velocity ("V") of money is equally critical. However, the accompanying graph illustrates a decline in CPI accompanied with climbing monetary velocity, the opposite of the anticipated effect.
Milton Friedman's assertion that inflation is a purely monetary phenomenon required an assumption that monetary velocity remain near constant. The pale blue line above is anything but constant. It turns out that the velocity of money is positively affected by changes in interest rates – when the cost of obtaining money rises, we try to use less of it for shorter periods of time. Unfortunately, this means that the velocity of money is likely to fall once the Fed begins cutting interest rates; unless the cut in interest rates spurs a dramatic increase in borrowing (expanding the QUANTITY of money), this is likely to push inflation down faster.
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Learn more about the Market Situation Report written by Tier 1 Alpha. |
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