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Velocity Of Money: Definition & Formula

Updated: May 18, 2022Written By: Logan KaneReviewed By:

One of the most debated concepts in economics is the velocity of money. Simply put, the velocity of money measures the number of times a unit of money is used to purchase goods and services within a given time period. For the United States, the M2 money stock changes hands a little more than once per year, which is considerably less than it was in decades past. The velocity of money is the subject of intense debates on inflation, GDP growth, government policy, and investing strategy.

Dollar bills flying in a circle

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What Is the Velocity of Money?

The velocity of money measures how fast money moves through the economy. It impacts inflation, GDP growth, government policy, and portfolio strategy. The key insight of the velocity of money is whether businesses and consumers are saving or spending money.

Here's the official definition of the velocity of money from the Federal Reserve.

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. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time.


After the 2008 financial crisis, the velocity of money was subject to a lot of debate in the investing community. After the Fed cut interest rates to zero and implemented quantitative easing, many expected rapid inflation to result. But this never happened, and one reason was that banks mostly just sat on the money while consumers and businesses deleveraged. The velocity of money fell again after the coronavirus pandemic, illustrating the challenge of central banks using quantitative easing to achieve policy goals.

How Money Velocity is Measured

Money velocity is measured either by:

  • M1: cash and checking accounts
  • M2: cash, checking accounts, and money markets/CDs

This is technical, but note that the Fed changed the definition of M1 and M2 in 2020, so comparing these figures to historic values is difficult. This also applies when comparing different countries—sometimes the data is comparable, and sometimes it isn't. Again, applying this key insight tells us that the velocity of money has fallen over time, which presents a frustrating conundrum to policymakers looking to boost the economy and to savers faced with low yields on their deposits.

How to Calculate the Velocity of Money

If you're an investor, you don't have to calculate anything, you can simply look this up on the FRED website and see the latest calculations from the Federal Reserve. If you're a finance student, then the main formula is as follows.

Money Velocity Formula

Velocity of Money = GDP / Money Supply

Sometimes the money velocity formula is written as some form of (Price*Real Expenditures/Money Supply (alternately this is sometimes written as Price * Quantity)/Money Supply), which mainly allows for you to separate nominal and real components of GDP and compare different points in time.

Money Velocity Chart

Money supply vs. money velocity

Money Supply vs. Money Velocity (Bloomberg)

Factors Influencing the Velocity of Money

As you can see, the velocity of money has slowed sharply over time. It's not yet settled why the velocity of money has slowed, but there has been a good deal of research from the Federal Reserve and by private individuals (flowbank.com) on this.

One reason it's slowed may be that the quantitative easing policies that have been used by the Federal Reserve and ECB were not super effective at creating demand growth after the 2008 recession, leading many observers to comment that the Fed was "pushing on a string" (Harvard Business Review).

In contrast, the massive fiscal stimulus after the coronavirus pandemic was very effective at creating demand, but money velocity decreased even further. It's the job of the economist to study this, but there isn't an irrefutable answer to why this is – plenty of past economics textbooks have had to be rewritten when their theories stop working!

Many factors that influence the velocity of money are somewhat technical, like banks participating in the repo market. But other factors are more demographic in nature and speak to some of the long-term trends in the economy. Put another way, if population growth slows, the demand for loans won't be as high as there will be fewer requests for banks to consider.

The Velocity of Money and Inflation

A high velocity of money is a classic inflation indicator. Inflation being so low after the 2008 crisis and so high after the COVID-19 pandemic has puzzled the Fed, and money velocity has decreased all the while.

But one thing that is somewhat clear is that if the velocity of money picks up, inflation would be very hard for the Fed to stop because of the sheer amount of money that has been injected into the system. This has implications both at home and abroad, as of 2022, the US dollar trades at a high and increasing premium (reuters.com) to the value implied by trade (purchasing power parity).

In short, in the way that all squares are rectangles but not all rectangles are squares, an increasing velocity of money is a strong inflation indicator, but the reverse is not necessarily true.

Interest Rates and the Velocity of Money

A minority view held by some economists is that QE (and especially negative interest rates in Europe) made their respective recessions worse by causing households to hold cash and extend the duration of their investments when they felt that normal bonds didn't offer enough compensation. There is some research/modeling on the relationship between interest rates and money velocity (mckendree.edu). There isn't significant evidence to prove or disprove this, but it's pretty clear that QE didn't really work as intended in the US or EU. History will tell us whether the Fed policies of the 21st century were effective or counterproductive to the economy and markets, but, as with a lot of areas of economics, the science is not always settled.

Note: The relationship between interest rates and money velocity may be also driven by a third variable, which is the money supply. Increasing the money supply (for example by QE) tends to lower interest rates and decrease the velocity of money. Increasing the money supply lowers interest rates by pure supply and demand, while the effect on money velocity is more indirect (more cash than good uses for it means that risk-averse banks would rather sit on the money than lend it.

Learn about the impact of interest rates on the stock market.

Bottom Line

The velocity of money has fallen sharply in the United States and other Western countries over time. The reasons for this range from possible policy errors to demographics, but the impact on your investment portfolio from Federal Reserve policies such as quantitative easing is worth studying in detail. The velocity of money is one such metric than can help you understand the economy and markets.

This article was written by

Logan Kane profile picture
Author and entrepreneur. My articles typically cover macroeconomic trends, portfolio strategy, value investing, and behavioral finance. I like to profit from the biases and constraints of other investors. Paywalled articles are available along with 1,000+ other authors by subscribing to Seeking Alpha Premium.You can read some more of my work for free here on my Substack.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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