Velocity of money

The speed of circulation of money , also the rate of turnover of money, is the frequency with which the available money supply is converted on average within a year.

General

The speed of circulation encompasses all types of payment , with cash payments circulating relatively more slowly than sight deposits , which are used much more frequently for payments than cash - and the trend is increasing.

The velocity of circulation is closely related to the amount of money necessary for economic activity and therefore plays an important role in quantity theory .

Microeconomic example

Let us consider a small economy consisting of a farmer, a sawmill and a mechanic who together have a sum of money of € 200. The mechanic wants to build himself a shelf, and the farmer wants to have his broken tractor repaired. The following transactions occur within one year:

	sales	Farmer	Sawmill	mechanic	GDP
Amount of money in the beginning		50 €	50 €	100 €
Farmer cuts a tree and sells it to the sawmill for € 50	50 €	100 €	0 €	100 €	50 €
The sawmill saws up the tree and sells the boards to the mechanic for € 100	100 €	100 €	100 €	0 €	50 €
Mechanic repairs tractor for € 100	100 €	0 €	100 €	100 €	100 €
to hum	250 €				€ 200

In microeconomics, the speed of rotation can be determined as. ${\ displaystyle V = sales \ div amount of money \ div time}$

The rotational speed is in this example . So the money runs more than once a year. ${\ displaystyle 250 \, \ mathrm {\ euro} \ div 200 \, \ mathrm {\ euro} \ div 1 \, {\ text {year}} = 1 {,} 25 / {\ text {year}}}$

The gross domestic product (GDP) in this example is only € 200, since the boards for € 100 already include the advance payment of the tree (€ 50) and therefore only € 50 of added value was created by the sawmill. This observation is important for the assessment of the macroeconomic possibilities of calculating the velocity of circulation.

If the farmer were to process his tree into boards himself and sell it directly to the mechanic, the total turnover would only be 200 € and thus the speed of rotation only . This shows that a higher vertical range of manufacture reduces the circulation speed. ${\ displaystyle 200 \, \ mathrm {\ euro} \ div 200 \, \ mathrm {\ euro} \ div 1 \, {\ text {year}} = 1 {,} 0 / {\ text {year}}}$

Macroeconomic view

The velocity of circulation is the ratio of the total economic sum of all real transactions (purchases) valued in money or a macroeconomic income variable to the macroeconomic money supply. The speed of circulation is the reciprocal of the cash holding coefficient , i.e. H. the average holding period of the money.

Today, one usually looks at a simplified form of the velocity of circulation, the velocity of circulation of income , in which a macroeconomic income variable - such as in particular the nominal gross domestic product - is related to the money supply. Since there are different concepts of the macroeconomic money supply , the various forms of the velocity of circulation also differ according to the measure used for the money supply.

With an abbreviation of the nominal gross domestic product , and for different types of money and with , and for the associated peripheral speeds is valid ${\ displaystyle Y}$ ${\ displaystyle M_ {1}}$ ${\ displaystyle M_ {2}}$ ${\ displaystyle M_ {3}}$ ${\ displaystyle V_ {1}}$ ${\ displaystyle V_ {2}}$ ${\ displaystyle V_ {3}}$

{\ displaystyle V_ {i} = {\ frac {Y} {M_ {i}}}}

The velocity of income in circulation neglects the following aspects:

Transactions in assets, e.g. B. The purchase of securities and real estate are not part of the gross domestic product, but can require more than half of the money supply. In economies with a high proportion of wealth transactions, the rate of income velocity is considerably lower than the actual velocity of money.
The gross domestic product only measures the value of the end products, not the value of the intermediate products converted along the value chain . With a low vertical range of manufacture , many intermediate products are traded on the way to the end product, which results in a higher number of transactions and thus increases the speed of circulation.
Only a part of the money, the transaction balance, is relevant for the gross domestic product . The speculative fund is used to store value and save and is only rarely involved in the domestic product. So if a high proportion of the money is hoarded, the value of the income circulation rate calculated as above will be low. Without a clear division of the money supply according to its use, it is difficult to tell whether the money supply is appropriate for economic activity. A low rate of income circulation may indicate that a large portion of the money supply is being hoarded.

Observations and theories about the velocity of rotation

The question of which long-term trend is the income velocity of money is controversial . The answer to this question depends, among other things, on the chosen money supply concept. In many developed economies is today a falling trend for individual nations (such as the UK) but there were earlier periods of longer-term stability. A long-term U-shaped curve has been demonstrated for a number of OECD countries. partially shows a rising trend. ${\ displaystyle V_ {3}}$ ${\ displaystyle V_ {2}}$ ${\ displaystyle V_ {1}}$

Velocity of the money supply M1 in the USA 1959–2012
Velocity of the money supply M2 in the USA 1959–2012
Velocity of the money supply MZM in the USA 1959–2012

The type of determination and the consequent velocity of circulation are the subject of controversy between different economic theories . Since it is assumed that payment habits (e.g. wages, salaries, taxes) are not subject to short-term fluctuations, adherents of quantity theory tend to believe that the velocity of circulation is technologically determined and stable as long as neither inflation nor deflation is expected and that such expectations do not arise as long as there are no signs that the general price level is changing.

In real terms, there is a long-term downward trend in Germany: The value of fell from 2.5 in 1970 to ~ 1.2 in 2010 or an average of 0.5% to 1% per year. One possible explanation for this is that the amount of money in circulation is growing faster than the gross domestic product every year . ${\ displaystyle V_ {3}}$

criticism

Ludwig von Mises said:

“The main deficiency of the velocity of circulation concept is that it does not start from the actions of individuals but looks at the problem from the angle of the whole economic system. This concept in itself is a vicious mode of approaching the problem of prices and purchasing power. It is assumed that, other things being equal, prices must change in proportion to the changes occurring in the total supply of money available. This is not true. "

“The main problem with the concept of velocity of circulation is that it does not start with individual actions, but looks at the problem from the perspective of the entire economic system. This concept in itself is a flawed way of approaching the problem of prices and purchasing power. It is believed that prices are proportional to the total amount of money if other factors remain the same. That is not true."

-

Knut Wicksell agrees with the explanations of quantity theory , but considers it vulnerable due to the criticism of its assumptions. He doubts the constancy of the speed of circulation or the cash holding time , as one of the "airiest and least tangible factors in the economy". He also criticizes the quantitative theoretical concept of money, since precious metals and coins are exchangeable in payment transactions through banknotes, bills of exchange or checks. As a result, the money supply degenerates into an endogenous size. In addition, an increase in the amount of precious metals could cause a decrease in the currency in circulation, so that the amount of money would remain the same. He also doubts that real cash holdings have a significant influence on the spending behavior of economic agents.

Individual evidence

^ Deutsche Bundesbank: Speed of circulation of money. Retrieved October 2, 2016 .

↑ ^a ^b Federal Statistical Office, quoted from Thomas von der Vring: Money and Monetary Policy - Critical Comments on Current Interpretations , 2012

^ Deutsche Bank Research, 1999

↑ Wolfgang Eichmann: Is the speed of money in circulation falling? In: Economic Service . Vol. 82, No. 2, 2002, pp. 99-101, ( digitized version (PDF; 282 KB) ).

^ Ludwig von Mises: Human Action (New Haven: Yale University Press, 1949) and The Theory of Money and Credit (London: Jonathan Cape, Limited, 1934, and New Haven: Yale University Press, 1953).

^ Knut Wicksell: Interest in money and prices of goods . 1898, quoted from Felderer, Homburg: Makroökonomik und neue Makroökonomik, 9th edition, Springer, 2005, p. 82

[1] Deutsche Bundesbank: Speed of circulation of money. Retrieved October 2, 2016 .

[:0-2] Federal Statistical Office, quoted from Thomas von der Vring: Money and Monetary Policy - Critical Comments on Current Interpretations , 2012

[3] Deutsche Bank Research, 1999