The Velocity of Money and Time Stamped Money

Governments around the world and particular the US have injected massive amounts of money into the economy in the hope to get people spending, it is after all a consumer economy (or actually a debt economy). According to Federal reserve the money supply as measured by M2 is now growing quite rapidly, see chart (2008 to Jan 2009). The FED do not release the broader money supply M3 anymore (and even broader money supply measures can be thought of), however there are some indications M3 is stabilizing after falling for a while, but more data is needed for any conclusion, and more date will come.

Injecting a lot of new money into the system should at some point spill over in inflation, but an important point to take into consideration could be the velocity of money. The velocity of money has to do with how quickly money change hands. Some macro economist think the velocity of money is not very important, other claims it is very important, personally I am in the later category. If the money supply is growing but just getting stashed away then we can still get deflation in common goods, even good businesses can be forced to close down due to reduced demand, businesses will go bankrupt, production will fall, unemployment will rise, and we are entering a bad circle feeding on itself, just like the madness of the credit boom was feeding on itself.

The velocity of money is probably closely linked to the confidence in the economy. If the confidence of the economy goes down so dose typically also the velocity of money. Even if I have money to spend I am less confident in the future of the economy, so it is rational for me to hold back a little even if the government should send me a check of money, I just stash it away. When many think the same this will reduce the velocity of money. This do not reduce the money supply but the speed of which money change hands.

Of course when the velocity of money comes back to “normal” at some point then together with increased money supply this will lead to inflation and potential even hyperinflation. However there is reason to think the velocity of money could stay low for quite some time, this again could result in more bankruptcies, more unemployment and deflation. Which again means the government will try to print even more money to solve the problem, but if the problem is velocity of money and not the money supply then this will not solve the problem, but just plant more seeds for deflation to spill over in massive inflation at some point down the road, it could take months or years, who knows.

Under the great depression money with time stamps got introduced. Or more precisely money that you had to pay a tax for if not used by the end of a given time limit. Of course most people wanted to avoid such tax, and people therefore tried to use the money as soon as possible, in other words the money quickly changed hands. If the government should handle out more money possibly they should think of handle out a version of such high velocity money. With today’s electronic fiat money there could be interesting possibilities for developing various sorts of high velocity money with some sort of time limit. Not necessary a suggestion, but something that we should look into before we potentially need it and not after we potentially need it. But it is always dangerous to play with something we have little experience with.