by Chris Casey
Typically defined as “the number of times one dollar is spent to buy goods and services per unit of time“, historically low monetary velocity is blamed for stymieing the Federal Reserve’s ability to achieve a targeted rate of price inflation. It is cited as delaying the onset of price inflation which was imminently predicted by some financial commentators in the aftermath of the Great Recession. It is viewedby all as problematic as it is powerful, as vexing as it is valid. Yet, despite its nature and magnitude having been debated for decades between Keynesian and Monetarist economists, monetary velocity is simply a pervasive and damaging myth.
The concept of velocity derives from the Fisher Equation of Exchange: MV=PT, where the quantity of money (M) times the velocity of its circulation (V) equals prices (P) multiplied bytheir related transactions (T). Initially developed by Copernicus, its modern manifestation was promulgated by the economist Irving Fisher in 1911. The equation attempts to explain increases (or decreases) in the price level: if the quantity of money expands, then prices will rise unless velocity decreases (or if transactions increase).
Valid criticisms of velocity are numerous: that the equation is merely tautological (it should be self-evident that prices paid for goods and services equal the prices charged for such goods and services), that the velocity of money cannot exist apart from the circulation of goods and services, that velocity is an effect and not a cause of price movements, etc. All of these arguments, while completely correct, avoid the primary reason velocity confuses mainstream economic prophets and financial prognosticators alike, for any theory of prices cannot ignore the demand for money. Murray Rothbard recognized this as the Fisher Equation’s fatal flaw: “it is this profound mistake that lies at the root of the fallacies of the Fisher equation of exchange: human action is abstracted out of the picture“. The abstraction of human action means the absence of monetary demand.
