what is the velocity of money 
the velocity of money is a measurement of the rate at which money is exchanged in an economy it is the number of times that money moves from one entity to another the velocity of money also refers to how much a unit of currency is used in a given period of time simply put it s the rate at which consumers and businesses in an economy collectively spend money the velocity of money is usually measured as a ratio of gross domestic product gdp to a country s m1 or m2 money supply the word velocity is used here to reference the speed at which money changes hands understanding the velocity of moneythe velocity of money is important for measuring the rate at which money in circulation is being used for purchasing goods and services it is used to help economists and investors gauge the health and vitality of an economy high money velocity is usually associated with a healthy expanding economy low money velocity is usually associated with recessions and contractions economists use the velocity of money to measure the rate at which money is used for goods and services in an economy while it is not necessarily a key economic indicator it can be followed alongside other key indicators that help determine economic health like gdp unemployment and inflation gdp and the money supply are the two components of the velocity of money formula economies that exhibit a higher velocity of money relative to others tend to be more developed the velocity of money is also known to fluctuate with business cycles when an economy is in an expansion consumers and businesses tend to more readily spend money causing the velocity of money to increase when an economy is contracting consumers and businesses are usually more reluctant to spend and the velocity of money is lower since the velocity of money is typically correlated with business cycles it can also be correlated with key indicators therefore the velocity of money will usually rise with gdp and inflation alternatively it is usually expected to fall when key economic indicators like gdp and inflation are falling in a contracting economy example of velocity of moneyconsider an economy consisting of two individuals a and b who each have 100 of money in cash individual a buys a car from individual b for 100 now b has 200 in cash money then b purchases a home from a for 100 and b enlists a s help in adding new construction to their home and for their efforts b pays a another 100 individual a now has 200 in cash individual b then sells a car to a for 100 and both a and b end up with 100 in cash thus both parties in the economy have made transactions worth 400 even though they only possessed 100 each in this economy the velocity of money would be two 2 resulting from the 400 in transactions divided by the 200 in money supply this multiplication in the value of goods and services exchanged is made possible through the velocity of money in an economy the velocity of money formulawhile the above provides a simplified example of the velocity of money the velocity of money is used on a much larger scale as a measure of transactional activity for an entire country s population in general this measure can be thought of as the turnover of the money supply for an entire economy for this application economists typically use gdp and either m1 or m2 for the money supply therefore the velocity of money equation is written as gdp divided by money supply velocity of money gdp money supply text velocity of money frac text gdp text money supply velocity of money money supplygdp gdp is usually used as the numerator in the velocity of money formula though gross national product gnp may also be used as well gdp represents the total amount of goods and services in an economy that are available for purchase in the denominator economists will typically identify money velocity for both m1 and m2 m1 is defined by the federal reserve as the sum of all currency held by the public and transaction deposits at depository institutions m2 is a broader measure of money supply adding in savings deposits time deposits and real money market mutual funds 1 as well the st louis federal reserve tracks the quarterly velocity of money using both m1 and m2 2velocity of money and the economythere are differing views among economists as to whether the velocity of money is a useful indicator of the health of an economy or more specifically inflationary pressures the monetarists who subscribe to the quantity theory of money argue that money velocity should be stable absent changing expectations but a change in money supply can alter expectations and therefore money velocity and inflation for example an increase in the money supply should theoretically lead to a commensurate increase in prices because there is more money chasing the same level of goods and services in the economy the opposite should happen with a decrease in money supply critics on the other hand argue that in the short term the velocity of money is highly variable and prices are resistant to change resulting in a weak and indirect link between money supply and inflation empirically data suggests that the velocity of money is indeed variable moreover the relationship between money velocity and inflation is also variable for example from 1959 through the end of 2007 the velocity of m2 money stock averaged approximately 1 9x with a maximum of 2 198x in 1997 and a minimum of 1 653x in 1964 3st louis federal reserve banksince 2007 the velocity of money has fallen dramatically as the federal reserve greatly expanded its balance sheet in an effort to combat the global financial crisis and deflationary pressures money velocity appeared to have bottomed out at 1 435 in the second quarter of 2017 and was gradually rising until the global recession triggered by the covid 19 pandemic spurred massive u s federal economic stimulus at the end of the second quarter of 2020 the m2v was 1 100 the lowest reading of m2 money velocity in history 3factors affecting the velocity of moneythere are several factors that can affect the velocity of money in an economy these include 