Money growth has been explosive. Some would say we are doomed to see inflation. That could be a likely scenario if money velocity is stable, but that is not the case. Simple money theory states that money times velocity will equal price times transactions.
However, during recessions there is an increase in money held by households, hence there is a decline in velocity. If there is a steeper economic decline or greater economic uncertainty, there will be a greater corresponding decline in velocity. There is the general view that the central bank should increase the supply of money to offset the velocity decline. The central bank will supply money to offset the increased demand.
In the current pandemic/lockdown case, money demand has increased, and velocity has declined. Velocity has been tied to financial innovation, but during period of recession or stress, the risk premia or flight to quality will drive velocity lower. A higher money supply is necessary to offset the increased money demand.
It makes sense for aggressive Fed action; however, the question for forward-looking expectations is what policy will be when velocity and money demand recede. Without an offset or an increase in economic transactions, prices will be forced higher. It is not a truism, but the reality from shifting money flows. How and when this will impact the economy and prices is not clear, but velocity will increase, and policy offsets will be necessary.
However, during recessions there is an increase in money held by households, hence there is a decline in velocity. If there is a steeper economic decline or greater economic uncertainty, there will be a greater corresponding decline in velocity. There is the general view that the central bank should increase the supply of money to offset the velocity decline. The central bank will supply money to offset the increased demand.
In the current pandemic/lockdown case, money demand has increased, and velocity has declined. Velocity has been tied to financial innovation, but during period of recession or stress, the risk premia or flight to quality will drive velocity lower. A higher money supply is necessary to offset the increased money demand.
It makes sense for aggressive Fed action; however, the question for forward-looking expectations is what policy will be when velocity and money demand recede. Without an offset or an increase in economic transactions, prices will be forced higher. It is not a truism, but the reality from shifting money flows. How and when this will impact the economy and prices is not clear, but velocity will increase, and policy offsets will be necessary.
No comments:
Post a Comment