'Velocity of money' is a stupid economic concept.
The economy is not about frantically flipping cash around. All credit matters, not just 'money'. Velocity doesn't carry signal in itself. It merely falls as a result of other liquidity sources ruling.
Disclaimer: The information contained in this article is not and should not be construed as investment advice. This is my investing journey and I simply share what I do and why I do that for educational and entertainment purposes.
A lot of nonsense is thrown around with respect to this metric and its impact on inflation that I feel compelled to add my two cents to it with a dedicated article.
TLDR Summary
Velocity of money paints a picture that economic growth is about frantically flipping cash around. But all credit matters, not just what is arbitrarily defined as money. And it’s not just about the speed at which is changes hands, it’s also about its implicit and explicit value as a collateral. I therefore prefer talking about the productivity of liquidity instead of the velocity of money.
Most government debt is not included in money supply. When it is issued as part of deficit spending, it drives economic growth without necessarily driving money supply. Velocity then falls as a pure byproduct of that process without carrying any (inflation) signal in itself.
Yes, falling velocity *can* be a monetary phenomenon, it typically isn’t. Instead it points to a fiscal phenomenon. It suggests that fiscal liquidity creation is outpacing credit liquidity creation.
I define the productivity of liquidity as GDP over total liquidity, incl. fiscal and credit liquidity. There is an instrument that can measure this productivity. It’s called interest rate. The more productive liquidity is, the higher the interest rate for its beneficiaries will be.
The issues with the velocity of money
The traditional macro researcher goes like this: Inflation happens when too much money chases too few goods and services. It is therefore first and foremost a function of the growth of money supply. However, to actually be inflationary, freshly printed money must be used in the economic transactions that contribute to GDP. This line of thinking has created the concept of the velocity of money, which is simply the ratio of nominal GDP to money supply.