Thursday, April 28, 2011

A Closer Look At Monetary Velocity

Let's finish looking at money supply by looking at velocity and GDP

From 1959 until 1984, there is a strong relationship between M1s YOY percentage change and GDPs YOY percentage change. This relationship breaks down briefly in 1974. In the above chart notice how the two lines mirror each other's movement.

The M1/GDP YOY percentage change relationship breaks down in the 1990s but returns to a certain extent in the 2000s. In the 2000s there is a very general arcing pattern to M1s chart as with GDP -- but this is a general relationship.

For about 15 of the 25 years in the above chart, M2's YOY percentage change in velocity mirrors GDP YOY percentage change. However, notice the relationship breaks down in the 1970s -- in fact, the relationship is almost inverted during this period.

From 1985 until 2010, the correlation between M2s YOY percentage change in velocity and the YOY percentage change in GDP is fairly high. From 1990-1995 the relationship is very strong. However, the relationship breaks down during the latter half of the expansion. There is a loose relationship between the two numbers during the 2000s expansion while there is a very close relationship during the last expansion.

With the exception of the mid-1970s, MZM and GDP's YOY percentage change in velocity show a strong correlation.

From 1985 until 2000 MZM's yearly percentage change becomes very volatile relative to the GDP change. During this period there appears to be little relationship between velocity and GDP. However, the MZM/GDP correlation returns over the last 10 years.

Of all the statistics, monetary velocity appears to have the strongest correlation with GDP growth. This makes strong intuitive sense. If people are spending money more rapidly there will be more activity; whereas if people are spending money less rapidly there is less activity.