Why the real velocity of money has not declined

People still cling to the myth that the velocity of money has declined in the last 10 years or so. Because of the way the so called money velocity is calculated newly created money must increase gross domestic product in order to affect the money velocity value. To get the value used they divide the parts of the money supply (M1, M2 & MZM) by the GDP, GDP/Money supply = money velocity.

So what happens in the case banks create money for speculation which does not increase GDP? The amount of money will increase and give a lower value, the velocity has slowed but in reality it has not, its used in the economy for financial transactions that does not give higher GDP. This creates the illusion of velocity decline.

In the last 15 year or more banks has expanded the part of the total money supply used for financial transactions rapidly, a majority of the total money in the economy is now used for speculation in the housing market and that explains why the charts below look like they do. When calculated correctly, with financial transactions included, the money velocity has not changed in any significant way. This is easy to understand if you really think about it, there’s no good reason why money velocity should fluctuate in any significant way, over time it should be flat and that’s what it has done.



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