The velocity of money

Date posted: February 4, 2011

What does it mean when economists talk about the velocity of money? Are they talking about something like the speed of money? N.C. State University economist Mike Walden answers.

“The velocity of money — the speed of money — it’s really the rate at which people spend money. That is, if you received $1,000 from some source, how quickly would you spend that or how quickly would you use that. You don’t necessarily have to spend it; you could put it into savings.

“And if people quickly spend it or quickly deploy that money, then we would say the velocity is high If they hang onto it for a while before spending it or deploying, then we would say velocity is low.

“And actually the velocity of money does vary over time. Typically when the economy is doing very well and in particular when interest rates are high, meaning that you don’t want to hold your money very long because you are losing effectively interest on that, then the velocity is high. But in downtimes during recessions, we tend to see the velocity go down. And we have seen that over the last couple of years.

“Now one impact of this Mary has to do with Federal Reserve policy. I think it is well known that the Federal Reserve has printed a whole bunch of money — in fact $1.5 trillion worth of cash effectively over the last couple of years and pumped that into the economy. Many economists and others worry that could spark higher inflation. It hasn’t; one reason is because that money isn’t turning over very rapidly. The velocity of money is very low. Once that velocity does pick up — and we’d expect it to pick up — then I think the fears of higher inflation are much more real.”

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