Everything about The Velocity Of Money totally explained
The
velocity of money is the average
frequency with which a unit of
money is spent. When the period is understood, the velocity may be present as a pure number; otherwise it should be given as a pure number over time. In the
equation of exchange, velocity of money is one of the key variables determining
inflation.
If, for example, in a very small economy, a farmer and a mechanic, with just $50 between them, buy goods and services from each other in just three transactions over the course of a year
- Mechanic buys $40 of corn from farmer.
- Farmer spends $50 on tractor repair.
- Mechanic spends $10 on barn cats from farmer
then $100 changed hands in course of a year, even though there's only $50 in this little economy. That $100 level is possible because each dollar was spent an average of twice a year, which is to say that the velocity was .
In practice, attempts to measure the velocity of money are usually indirect:
»
where
» is the velocity for transactions counting towards
national or domestic product.
is nominal
national or domestic product, and each such transaction is made up of a price part times a quantity purchased part.
The determinants and consequent stability of the velocity of money are a subject of controversy across and within
schools of economic thought. Those favoring a
quantity theory of money have tended to believe that, in the absence of
inflationary or
deflationary expectations, velocity will be technologically determined and stable, and that such expectations won't generally arise without a signal that overall prices have changed or will change.
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