One more time….The Velocity of Money

by Laura Ehrenberg-Chesler on August 7, 2014

in Banks,Economic Indicators,Fed policy,inflation/deflation,interest rates

In looking back at some June research from Charles Schwab and Company, on the exit from Quantitative Easing and inflation, I found an interesting passage on the relationship between the velocity of money and inflation.  We have previously discussed this on our blog, but it is certainly worth revisiting.

Rather than increase lending and thereby multiply the money circulating in the economy, banks are holding high levels of reserves on their balance sheets and placing excess reserves at the Fed, where they earn a mere 0.25%.  As of May 29, reserve balances at the Fed stood at $2.7 trillion – compared to $16.1 billion in December 2007.  Consequently, the “velocity of money” in the financial system has been falling steadily over the past few years and is now at its lowest level in more than 50 years.  There is no historic evidence of inflation rising when the velocity of money is declining.” 

It will be important to watch lending growth in order to evaluate whether economic growth and inflation are making a comeback.

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