Department of “Huh?!”: What Does Money Velocity Tell Us about Low Inflation in the U.S.
Yi Wen and Maria Arias appear to say that the Federal Reserve has done two independent things since 2008:
- Increased the stock of money at 33%/year.
- Pursued an unconventional exceptionally-low interest-rate policy that has reinforced the recession.
The extremely strong implication of their piece is that the Federal Reserve could have (a) kept money growth strong and produced a high money stock while (b) keeping interest rates from falling to the zero lower bound, or, alternatively (a) kept the money growth rate low and produced a relatively small money stock constant while still (b) pursuing an exceptionally-low interest-rate policy.
Can somebody please tell me how the Federal Reserve was supposed to strongly decouple the rate of money growth, the level of the money stock, and the level of interest rates over a period as short as five years? Yes, a period of high money growth is consistent with high interest rates at its end if it is accompanied by even higher inflation that reduces that real money stock. And yes, a period of low money growth is consistent low interest rates at its end if it is accompanied by deflation that raises the real money stock.
But that’s not what they are talking about, is it? What are they talking about?
Yi Wen and Maria A. Arias: What Does Money Velocity Tell Us about Low Inflation in the U.S.?: “The following equation: MV = PQ…. M stands for money. V stands for the velocity of money (or the rate at which people spend money). P stands for the general price level. Q stands for the quantity of goods and services produced. Based on this equation, holding the money velocity constant, if the money supply (M) increases at a faster rate than real economic output (Q), the price level (P) must increase to make up the difference. According to this view, inflation in the U.S. should have been about 31 percent per year between 2008 and 2013, when the money supply grew at an average pace of 33 percent per year and output grew at an average pace just below 2 percent. Why, then, has inflation remained persistently low (below 2 percent)?… The answer lies in the private sector’s dramatic increase in their willingness to hoard money…. And why then would people suddenly decide to hoard money instead of spend it?…. 1. A glooming economy…. 2. The dramatic decrease in interest rates…. The unconventional monetary policy has reinforced the recession… through pursuing an excessively low interest rate policy…