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Macro Economics
The Velocity of Money

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By WendyBG
October 16, 2009

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There may be an ocean of liquidity pumped into the banks by the Fed, but the real economy is supported by consumer spending, which is about 70% of GDP.

Let's say that Jeff sells a security system. Then his DW spends part of this money on a nice piece of salmon. The fisherman buys a net. The net-maker buys rope. The rope-maker buys braces for his kid. The orthodontist buys a pair of earrings for his wife. The jeweler... you get the picture. One dollar of money earned can change hands to generate many transactions. The higher the velocity, the higher the economic activity.

The faster the money is spent, the higher the "monetary velocity," which the Fed measures as the ratio of GDP to money that is ready to be spent.

Here is a chart of velocity.

http://research.stlouisfed.org/publications/mt/page12.pdf

The most sensitive parameter is MZM.

http://en.wikipedia.org/wiki/Money_with_zero_maturity

"It measures the supply of financial assets redeemable at par on demand." -- That is: cash, checking accounts, savings accounts and money market accounts -- money that can be spent immediately.

Notice that velocity has been dropping steeply since 2006. GDP/MZM fell from about 1.9 in 2006 to under 1.5 today. That shows that people aren't shopping as much from their liquid money (cash, checking, money markets).

But you can say, what about shopping on credit?

MZM doesn't include credit. It's only real, spendable money, not borrowed money.

People do spend a lot using credit. The Fed tracks several types of consumer credit.

Consumer Revolving Credit Owned by Commercial Banks
http://research.stlouisfed.org/fred2/graph/?chart_type=line&s[1][id]=REVOLNCB&s[1][range]=5yrs

Consumer Revolving Credit Owned by Credit Unions
http://research.stlouisfed.org/fred2/graph/?chart_type=line&s[1][id]=REVOLNCU&s[1][range]=5yrs

Consumer Revolving Credit Owned by Finance Companies
http://research.stlouisfed.org/fred2/graph/?chart_type=line&s[1][id]=REVOLNFC&s[1][range]=5yrs

Consumer Revolving Credit Owned by Nonfinancial Businesses
http://research.stlouisfed.org/fred2/graph/?chart_type=line&s[1][id]=REVOLNNFC&s[1][range]=5yrs

Consumer Revolving Credit Owned by Savings Institutions
http://research.stlouisfed.org/fred2/graph/?chart_type=line&s[1][id]=REVOLNSAV&s[1][range]=5yrs

The Federal Reserve tracks these separately, so I added them up. The year-end holiday shopping shows a spike each year, so I also did a 12-month moving average.

[See Post for Table]

Revolving consumer credit reached a peak in March 2009. It's been falling since then.

But that doesn't include all consumer credit. What about auto and student loans, etc?

Household Sector: Liabilities: Household Credit Market Debt Outstanding
http://research.stlouisfed.org/fred2/graph/?chart_type=line&s[1][id]=CMDEBT&s[1][range]=5yrs

Household debt peaked in early 2008 and has been dropping since then.

For one thing, sales of cars and light trucks dropped after "cash for clunkers."

http://research.stlouisfed.org/fred2/graph/?chart_type=line&s[1][id]=ALTSALES&s[1][range]=5yrs

This paints a rather dismal picture of a slowing consumer economy. The single bright spot is that Personal Consumption Expenditures are beginning to pick up since the depths of the panic.

http://research.stlouisfed.org/fred2/graph/?chart_type=lines[1][id]=PCE&s[1][range]=5yrs

However, personal income has not recovered.
http://research.stlouisfed.org/fred2/graph/?chart_type=line&s[1][id]=PI&s[1][range]=5yrs

The bottom line is that retail sales have dropped in a way that the 2001 recession didn't experience.

http://research.stlouisfed.org/fred2/series/RSXFS

The velocity of money is down. People are earning less, borrowing less and spending less.

Unless consumer sentiment picks up considerably, it's going to be a dismal Christmas shopping season.

http://research.stlouisfed.org/fred2/graph/?chart_type=line&s[1][id]=UMCSENT&s[1][range]=5yrs

I don't think that's going to happen.

Retailers will be hurt...except possibly the low cost retailers, such as Wal-Mart.


Wendy