Velocity of money
Encyclopedia
Frequency
Frequency is the number of occurrences of a repeating event per unit time. It is also referred to as temporal frequency.The period is the duration of one cycle in a repeating event, so the period is the reciprocal of the frequency...
with which a unit of money
Money
Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally in the past,...
is spent in a specific period of time
Time
Time is a part of the measuring system used to sequence events, to compare the durations of events and the intervals between them, and to quantify rates of change such as the motions of objects....
. Velocity has to do with the amount of economic activity associated with a given money supply
Money supply
In economics, the money supply or money stock, is the total amount of money available in an economy at a specific time. There are several ways to define "money," but standard measures usually include currency in circulation and demand deposits .Money supply data are recorded and published, usually...
. When the period is understood, the velocity may be presented as a pure number; otherwise it should be given as a pure number over time. In the equation of exchange
Equation of exchange
In economics, the equation of exchange is the relation:M\cdot V = P\cdot Qwhere, for a given period,M\, is the total nominal amount of money in circulation on average in an economy.V\, is the velocity of money, that is the average frequency with which a unit of money is spent.P\, is the price...
, velocity of money is one of the variables claimed to determine inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
.
Illustration
If, for example, in a very small economy, a farmerFarmer
A farmer is a person engaged in agriculture, who raises living organisms for food or raw materials, generally including livestock husbandry and growing crops, such as produce and grain...
and a mechanic
Mechanic
A mechanic is a craftsman or technician who uses tools to build or repair machinery.Many mechanics are specialized in a particular field such as auto mechanics, bicycle mechanics, motorcycle mechanics, boiler mechanics, general mechanics, industrial maintenance mechanics , air conditioning and...
, with just $50 between them, buy goods and services from each other in just three transactions over the course of a year
- Farmer spends $50 on tractorTractorA tractor is a vehicle specifically designed to deliver a high tractive effort at slow speeds, for the purposes of hauling a trailer or machinery used in agriculture or construction...
repair from mechanic. - Mechanic buys $40 of cornMaizeMaize known in many English-speaking countries as corn or mielie/mealie, is a grain domesticated by indigenous peoples in Mesoamerica in prehistoric times. The leafy stalk produces ears which contain seeds called kernels. Though technically a grain, maize kernels are used in cooking as a vegetable...
from farmer. - Mechanic spends $10 on barn cats from farmer.
then $100 changed hands in course of a year, even though there is only $50 in this little economy. That $100 level is possible because each dollar was spent an average of twice a year, which is to say that the velocity was
.Indirect measurement
In practice, attempts to measure the velocity of money are usually indirect:
where
is the velocity of money for all transactions.
is the nominal value of aggregate transactions.
is the total amount of moneyMoney supply
In economics, the money supply or money stock, is the total amount of money available in an economy at a specific time. There are several ways to define "money," but standard measures usually include currency in circulation and demand deposits .Money supply data are recorded and published, usually...
in circulation on average in the economy (see “Money supply
Money supply
In economics, the money supply or money stock, is the total amount of money available in an economy at a specific time. There are several ways to define "money," but standard measures usually include currency in circulation and demand deposits .Money supply data are recorded and published, usually...
” for details).
(Given the classical dichotomy
Classical dichotomy
In macroeconomics, the classical dichotomy refers to an idea attributed to classical and pre-Keynesian economics that real and nominal variables can be analyzed separately...
,
may be factored into a product 
of a price levelPrice level
A price level is a hypothetical measure of overall prices for some set of goods and services, in a given region during a given interval, normalized relative to some base set...
and a 'real' aggregate value of transactions 
.)Values of
and 
permit calculation of 
.As applied to an economy, expenditures on final output are of interest; the relation may be written:
where
is the velocity for transactions counting towards national or domestic productMeasures of national income and output
A variety of measures of national income and output are used in economics to estimate total economic activity in a country or region, including gross domestic product , gross national product , and net national income . All are specially concerned with counting the total amount of goods and...
.
is nominal national or domestic productMeasures of national income and output
A variety of measures of national income and output are used in economics to estimate total economic activity in a country or region, including gross domestic product , gross national product , and net national income . All are specially concerned with counting the total amount of goods and...
.
(Analogously with
, given the classical dichotomyClassical dichotomy
In macroeconomics, the classical dichotomy refers to an idea attributed to classical and pre-Keynesian economics that real and nominal variables can be analyzed separately...
,
may be factored into a product 
.)Determination
The determinants and consequent stability of the velocity of money are a subject of controversy across and within schools of economic thought. Those favoring a quantity theory of moneyQuantity theory of money
In monetary economics, the quantity theory of money is the theory that money supply has a direct, proportional relationship with the price level....
have tended to believe that, in the absence of inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
ary or deflationary expectations, velocity will be technologically determined and stable, and that such expectations will not generally arise without a signal that overall prices have changed or will change.
The view that velocity of money is constant is criticized by Samuelson
Paul Samuelson
Paul Anthony Samuelson was an American economist, and the first American to win the Nobel Memorial Prize in Economic Sciences. The Swedish Royal Academies stated, when awarding the prize, that he "has done more than any other contemporary economist to raise the level of scientific analysis in...
thus:
Sources
- Cramer, J.S. “velocity of circulation”, The New Palgrave: A Dictionary of Economics(1987), v. 4, pp. 601-02.
- Friedman, Milton; “quantity theory of money”, in The New Palgrave: A Dictionary of Economics (1987), v. 4, pp. 3-20.
External links
- Velocity of money data - from the St. Louis Fed's FRED database