The Velocity of Money is a measure of the number of times that the average unit of currency is used to purchase goods. The concept relates the size of economic activity to a given money supply and the speed of money exchange is one of the variables that determine inflation. (Wikipedia).

To calculate the velocity of money you simply divide Gross Domestic Product (GDP) which is the total of everything sold in the country by the Money supply. Thus Velocity of Money = GDP / Money Supply.

The reason to worry over a low money supply is if it reflects a shrinking economy or continued down growth. If, on the other hand, the declining velocity is due to the money supply growing faster than a growing economy , this should indicate a problem. When GDP growth was weak, the money supply grew faster (blog.commonwealth.com).

In other words, the measure of the velocity of money is usually the ratio of gross national product (GNP) to a countries money supply. If the velocity of money is increasing, the transactions are occurring between individuals more frequently.

As of the second quarter of 2019, M2 velocity of money was 1.457. Money velocity has been increasing from its most recent trough of 1.432 in the second quarter of 2017 ( Investopedia) .

I found this example on Facebook, author unknown. ” This is actually a real economic concept called the velocity of money. Let’s say you get paid $10, you use the $10 to buy lunch from a street vendor, then the street vendor uses the $10 to take a taxi home, then the taxi driver uses the $10 to buy groceries, etc. That one $10 bill produced $50 of economic value. This is really good for the economy and why it’s bad to give rich people more and more money because all rich people do is horde it. They do not stimulate the economy multiple times over with it.” By all means, this is food for thought.


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Learn more about finance terms at Investopedia

Categories: Finance

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