... your velocity correlation with interest rates no longer work when every dollar has to chase every burden but consumption
... a post consumption dollar will not have the same correlation IMO
The true correlation to the velocity of money, pre-2008 crash, is inflation. The FED uses the FED FUNDS rate to execute higher interest rates based upon cooling down inflation. At what cost? Higher unemployment; businesses respond by not holding or producing inventory and people are induced to save (higher interest rates results in deferred spending as people choose to not spend realizing a benefit of future spending power).
So there is a trade off with higher interest rates and unemployment and the benefit is lower inflation as spending falls.
is the velocity of money for all transactions.
is the nominal value of aggregate transactions.
M is the total amount of money in circulation on average in the economy.
The short hand way of calculating V is to divide the GDP by M.
If people are fearful of the economy they want to hold Cash or cash equivalents. They aren’t going to put money in a CD or long term holding. They want it readily available. So that if they lose their job or run into a credit crunch they will have the cash they need to continue living their lives.
In the chart below we see the velocity of money using the M1 money supply. The grey shaded areas are official recessions and you can see that during these periods the velocity of money is shrinking. Interestingly during those periods GDP and the money supply itself can also be shrinking. The GDP of course might shrink because demand for goods decreases due to people holding onto their money longer. But as people default on their debts or pay them off the money supply itself might shrink but that would probably be longer term money rather than M1 so that is another reason why using M1 might be the best indicator.
Strictly speaking all the velocity of money tells us is how long people actually hold onto their money. But from that we can infer their motives and perceptions of their personal finances and on a broader scale the economy in general.
If people are fearful for their jobs they will want to hold more cash and thus the velocity of money will fall. If on the other hand, they feel “flush with cash” they will spend it faster. But there are other reasons people spend cash quickly. The primary one is that they fear inflation. So rather than feeling rich a high velocity may also indicate a fear of the value of their money depreciating quickly. A perfect example of this would be during the Hyperinflation in Weimar Germany between 1921 and 1923. During this time inflation got so bad that people would pay for their meal before the meal because if they waited until the end it would cost more. This is the ultimate in money velocity where people rush out to spend the money because holding it for a few minutes longer might cause it to lose additional value.
We can tell that the economy is not rebounding. In 2009 the velocity of money picked up a little bit. People were induced to spend and thinking that the recession was over and the economy would improve and so they began to spend a little bit more. This could have been the result of the QE1 stimulus and cash for clunker, and tax credits for buying a house and green energy improvements. Not much in exchange for a Trillion dollars worth of debt. But the current fall indicates that people are not convinced that the recession is over and that they would once again rather hold cash than spend it. It also indicates that people are not afraid of inflation, at least in the short term they still want to hold onto their cash.
