Nice. But while I understand various things encapsulated under the term “financial innovation” that might explain these long-term trends, I’m having trouble coming up with a coherent story.

The Arthurian

Asking why velocity tends to go down is the same as asking why GDP tends to go down relative to money, or why money tends to increase relative to GDP.

But… What money are we counting? As the link in my prior comment shows, we are counting not only the money people spend but also the money people have saved. (M1 is the money we spend. M2 is the money we spend plus the money we have saved.)

Now in general, we save only a small part of our income. But the savings counted in money measures (other than M1) is not the annual addition or flow, but the entire accumulation or stock of savings.

Over time, the stock of savings increases relative to the stock of money we spend. Therefore the quantity of money used for the velocity calculation gradually becomes much greater than the quantity of money which is being spent in the purchase of GDP. This slowly bloating denominator drives the velocity value down over time.

## Comments

## 5 responses to “Money Velocity Since 1869: Somebody Please Tell Me What to Think About This”

Think financial innovation.

The “money” used to produce the above graph is not identified in the NBER data, so I compared it to the velocity of the money measures we use today.

http://research.stlouisfed.org/fredgraph.png?g=im3

Comparable to M2 or MZM but definitely not M1.

The MZM velocity makes a nice addition to your graph, as it has a peak around 1980 that is reminiscent of the 1880 peak shown above.

@The Arthurian

Nice. But while I understand various things encapsulated under the term “financial innovation” that might explain these long-term trends, I’m having trouble coming up with a coherent story.

Asking why velocity tends to go down is the same as asking why GDP tends to go down relative to money, or why money tends to increase relative to GDP.

But… What money are we counting? As the link in my prior comment shows, we are counting not only the money people spend but also the money people have saved. (M1 is the money we spend. M2 is the money we spend plus the money we have saved.)

Now in general, we save only a small part of our income. But the savings counted in money measures (other than M1) is not the annual addition or flow, but the entire accumulation or stock of savings.

Over time, the stock of savings increases relative to the stock of money we spend. Therefore the quantity of money used for the velocity calculation gradually becomes much greater than the quantity of money which is being spent in the purchase of GDP. This slowly bloating denominator drives the velocity value down over time.

Wow, I hope that’s coherent!

Easy: Don’t.