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Why does MV = PY? Because V is only defined as PY/M. V has no other tangible definition. If you disagree, then please show me how you can determine V independently. I thought this was common knowledge. I am disappointed that you would write something like this.

Not your best post.

1. There are no plus signs in the MV=PY equation. Where'd that come from?

2. M2 velocity is effectively zero relative to M2 level. Ditto CPI vs GDP.

So you're showing M2 growth versus GDP growth. Not much light there. Says nothing about MV=PY.

Try playing with it using household net worth as M. Gets pretty interesting.

"The M2 money supply is basically the money in circulation apart from reserves that banks hold with the Federal Reserve. "

I have been wondering if M2 included those bank reserves with the FED.

Very interesting that Velocity is still going down, even though M2 is only growing normally. This touches on something that we had discussed before. I believe that lower income earners are much more likely to spend their income and therefore contribute more to Velocity.

Why are you using Velocity of M2 + M2? Scaling for the graph?

As you say, V spits out of PY/M. Why does that discount V? It is a logical deduction.
Milton Friedman was wrong when he said velocity was constant. That created trouble. So now we know that velocity can change and how.

Hi Steve,
The plus signs come with percent changes. So I use percent over year change, just like an inflation rate is the percent change over the last year.
But MV=PY can also be written as %∆M + %∆V = %∆P + %∆Y. If the right side changes by 4%, the left side has to too.

But the velocity of M2 has not been zero. It has been changing yearly by over -2% for 3 years now.
That is not interesting?

Hi Jim,
I use the percent changes because it is just easier to see how the equation works using FRED graphs.
So you think velocity is low because money is being distributed to higher income earners? That is interesting.

"... we know that velocity can change and how."

Okay, if you could independently define V, that would prove me wrong. I don't think the economy works that way and any attempt results in a ptolemaic model. But, I am open minded.

Take an economy where nothing changes... real output, money supply in circulation, new investment, productive capacity, utilization of labor and capital... all that stays the same. Also the velocity of money has a ratio of 2. Inflation is 0%.
Now what would happen if all of a sudden real GDP starts to rise 2% continuously because of increased productivity?
Holding velocity constant, inflation would go to -2% continuously in order for the money supply to circulate to buy the increased quantity of goods and services.
But what if you have price stickiness and prices do not drop. Then velocity will have to grow by 2% continuously.
The likelihood is that you will see some price declines and some increases in velocity due to falling prices. So price stickiness causes changes in velocity.

Ultimately if inflation is to stay at 0%, you may end up with velocity increasing 1%, and the money supply increasing 0.5% (not 1% since money supply is half of nominal GDP).

So velocity is part of the dynamics of inflation.
If velocity gets pushed too high due to a lack of money supply, the economy experiences friction in its transactions. It would be better to inject more money in order to bring velocity into a comfortable zone.

It goes back to the idea of homeostasis which allows life to exist. Physiology has a certain rhythm that optimizes bodily functions. If you speed up a rhythm, you risk optimal homeostasis and sickness.
Such is the case of velocity. A velocity of 10 is much too high. You are forcing people to move money too fast in order to meet nominal GDP demands. A velocity of .5 is much too low. You are not letting people do enough transactions to express their demands. Money is sitting idle.
According to the graph at this link...

The normal velocity is around 1.75. In the 20 years before the crisis, velocity was running over 2. That tells me that incentives were forcing people to move money too much. The result was bubbles and the like.
It is more sustainable to have a velocity over 1 and less than 2. Why?
You at least want all money to move once. Also you do not want money to move more than twice as that increases debts too much. People all of a sudden do not have the money to keep up with high velocity spending so they borrow.

Velocity tells an important part of the overall picture.


Correct me if I am wrong, but your longer form description still defines V as PY/M. You have not said anything about how V is independently established.

PY and M are the only independently observable values. The fact that PY/M fluctuates so much tells me that there is not a strong relationship between PY and M.


V has meaning.
When V is less than 1, you have money that does not enter into transactions. There would be too much money.
When V is more than 2, there are distortions from policies that try to move money faster. Output becomes inflated over natural trends.

PY/M is just V. Yet, V does not fluctuate tremendously. Even the Fed seeks stability in P.
Once you have well-anchored expectations of P due to Fed credibility, then MV respond more to changes in Y.

PY is nominal output.
MV is nominal money flow.

A key aspect of controlling M is to obtain an optimal V between 1.5 and 1.8.

It is no problem that V cannot be measured directly. We can still deduce it. There are other variables that are obtained by deduction... like capacity utilization.

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Data as of 3rdQ-2018
Effective Demand = $18.433 trillion
Real GDP = $18.671 trillion
Productive Capacity = $24.872 trillion
UT index is at effective demand limit = -0.92%
Effective demand limit = 74.1%
TFUR = 75.1%
ED Fed rate rule = 4.0%
Estimated Natural Real Interest rate = 2.3%
Short-term real interest rate = 2.8%

There is no recession for 3rdQ-2018. Chance of recession is growing as economy has now reached 2nd effective demand limit in this business cycle. I am forecasting that economic conditions will begin to contract in the second half of 2018.

Click on Graphs below to see updated data at FRED.

UT Index (measure of slack):

The UT Index



z derivatives in terms of labor & capital:

z derivatives in terms of labor & capital

Effective Demand, real GDP & Potential GDP:

ED, real GDP & pot rGDP

ED Output Gap:

ED Output gap

Corporate profit rate over real cost of money:

Corp profit rate over real cost of money

Exponential decay of Inflation:

Corporate profits impact Inflation

Measures of Inflation:

Measures of Inflation

YoY Employment change:

YoY employment change

Speed of consuming slack: yoy monthly:

Speed of consuming slack

Speed of consuming slack: quarterly:

Speed of consuming slack quarterly

Real consumption per Employee:

real consumption per employee 2

Will real wages ever rise faster than productivity?:

Productivity & Real Wages



Productivity against Effective Demand limit:

Prod & ED limit

Bottom of Initial Claims?:

Initial claims

Tracking inflation expectations:

Fisher effect?

M2 velocity still falling:

Measures of Inflation

All in one:

All in one

Double checking labor share with unit labor costs & inflation:

My Photo
Edward Lambert: Independent Researcher on Effective Demand. Graduate of Atlantic International University where independent research was developed.
Some links for economic analysis
Fed Views - San Francisco Fed, around 10th of each month.
Well's Fargo monthly - around 10th of each month
Well's Fargo weekly
Well's Fargo Interest rate report
Well's Fargo Economic indicators
T. Rowe Price weekly market wrap-up
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