velocity of money

Examples of velocity of money in the following topics:

• Defining Inflation

  • This idea is known as the quantity theory of money .
  • In mathematical terms, the quantity theory of money is based upon the following relationship: M x V = P x Q; where M is the money supply, V is the velocity of money, P is the price level, and Q is total output.
  • In the long run, the velocity of money (that is, how quickly money flows through the economy) and total output (that is, an economy's Gross Domestic Product) are exogenous.
  • Instead, for example, an increase in the money supply could boost total output or cause the velocity of money to fall.
  • This is consistent with the quantity theory of money.

• Deflation

  • When this happens, the nominal prices of goods are falling on average and the purchasing power of money is increasing.
  • There are several theories about the causes of deflation.
  • Recall that in monetarist theory, Money Supply*Velocity of Money = Price Level*Output.
  • According to monetarist economists, therefore, deflation is caused by a reduction in the money supply, a reduction in the velocity of money, or an increase in the number of transactions.
  • However, any of these may occur separately without causing deflation as long as they are offset by another change - for example, the velocity of money could rise and the money supply could fall without causing a change in price levels.

• Limitations of Monetary Policy

  • Inflation reduces the real value of money over time; conversely, deflation increases the real value of money.
  • This allows one to buy more goods with the same amount of money over time.
  • From a monetary policy perspective, deflation occurs when there is a reduction in the velocity of money and/or the amount of money supply per person.
  • The velocity of money is the frequency at which one unit of currency is used to purchase domestically-produced goods and services within a given time period.
  • If the velocity of money is increasing, then more transactions are occurring between individuals in an economy.

• Other Measurements of the Money Supply

  • M2: M1 + most savings accounts, money market accounts, retail money market mutual funds, and small denomination time deposits (certificates of deposit of under $100,000).
  • MZM: "Money Zero Maturity" is one of the most popular aggregates in use by the Fed because its velocity has historically been the most accurate predictor of inflation.
  • The different forms of money in the government money supply statistics arise from the practice of fractional-reserve banking.
  • This new type of money is what makes up the non-M0 components in the M1-M3 statistics.
  • The measures of the money supply are all related, but the use of different measures may lead economists to different conclusions.

• The Definition of Money

  • The value of commodity money comes from the commodity out of which it is made.
  • Paper money is an example of fiat money.
  • Economists sometimes note additional functions of money, such as that of a standard of deferred payment and that of a measure of value.
  • The status of money as legal tender means that money can be used for the discharge of debts.
  • Distinguish between the three main functions of money: a medium of exchange, a unit of account, and a store of value

• The Money Multiplier in Theory

  • The money multiplier measures the maximum amount of commercial bank money that can be created by a given unit of central bank money.
  • When you think of money, what you probably imagine is commercial bank money.
  • The money multiplier measures the maximum amount of commercial bank money that can be created by a given unit of central bank money.
  • The above equation states that the total supply of commercial bank money is, at most, the amount of reserves times the reciprocal of the reserve ratio (the money multiplier) .
  • A 10% reserve requirement creates a total money supply equal to 10 times the amount of reserves in the economy; a 20% reserve requirement creates a total money supply equal to five times the amount of reserves in the economy.

• The Demand for Money

  • In economics, the demand for money is the desired holding of financial assets in the form of money (cash or bank deposits).
  • However inherent to the holding of money is the trade-off between the liquidity advantage of holding money and the interest advantage of holding other assets.
  • It is viewed as a "cost" of borrowing money.
  • While the demand of money involves the desired holding of financial assets, the money supply is the total amount of monetary assets available in an economy at a specific time.
  • Relate the level of the interest rate to the demand for money

• Shifts in the Money Demand Curve

  • In economics, the demand for money is the desired holding of financial assets in the form of money.
  • The interest rate is the price of money.
  • The quantity of money demanded increases and decreases with the fluctuation of the interest rate.
  • The demand for money is a result of the trade-off between the liquidity advantage of holding money and the interest advantage of holding other assets.
  • The graph shows both the supply and demand curve, with quantity of money on the x-axis (Q) and the price of money as interest rates on the y-axis (P).

• Present Value and the Time Value of Money

  • The time value of money is the principle that a certain amount of money today has a different buying power (value) than in the future.
  • The time value of money is the principle that a certain amount of money today has a different buying power (value) than the same currency amount of money in the future.
  • The value of money at a future point of time would take account of interest earned or inflation accrued over a given period of time.
  • The return of $5 represents the time value of money over the one year interval .
  • The time value of money is the central concept in finance theory.

• The Equilibrium Interest Rate

  • In a economy, equilibrium is reached when the supply of money is equal to the demand for money.
  • Equilibrium is reached when the supply of money is equal to the demand for money.
  • Consumption: the level of consumption (and changes in that level) affect the demand for money.
  • In the case of money supply, the market equilibrium exists where the interest rate and the money supply are balanced.
  • Use the concept of market equilibrium to explain changes in the interest rate and money supply