## Tuesday, September 6, 2011

### M1 above, M2 below.

Jim writes: "I've been looking at this chart."

 Graph #1: jim's chart ORANGE = M2 Money Supply (billions) BLUE = A constant portion of GDP GREEN = (to be discussed later)
He describes the chart:

It is a comparison of the money stock to GDP. During expanding credit bubble the ratio of money to GDP was about .5 at all other times money stock appears to be around .6*GDP.

I thought this was very interesting.

I will ignore that green line for now. Just look at the orange and blue. Very similar for a long while. Then an obvious separation. Then they run parallel again, but not so close together.

First impression: Except for a brief period, the two lines run parallel. So a ratio of one to the other would be, I expect, would be constant for the most part. (This is why I do graphs: to see how what "I expect" stands up. To learn to guess better.)

The first place my mind goes with that is right back to Milton Friedman. Back maybe in the 1970s, Keynesians said, yeah, Friedman would be right about money and inflation *IF* the velocity of money was constant, but it isn't constant.

Looks pretty constant from the trend lines above.

If you take jim's trend lines and divide the GDP number by the Money number, you get a measure of velocity.

 Graph #2: A Measure of Velocity
From the first data to the late 1970s, the trend line varies by five percent or less from M2 money being EQUAL to 60% of GDP. That shows up on Graph #1 as the two trend lines being indistinguishable. The variation is small enough that we might want to say the velocity was constant in those years.

After that, we get some taller spikes on graph #2
1. A peak that starts around 1977 and dies around 1983.
2. A lesser peak that starts around 1983 and dies around 1986.
3. A great peak that starts around 1986 and dies around 2003.
4. And a lesser peak with a greater drop-off that returns the trend-line to the 1.00 level.

These peaks appear on Graph #1 as separations between the two trend lines. These separations remind me of the "speed bumps" in M1 money growth that I've looked at over the past couple of days. One thing is different, however. Where there are separations on Graph #1 above, the trend of M2 Money is below the trend of income.

The speed-bumps of M1 Money put money at or above the trend of income.

jim said...

Hi Arther,

Graph #2 is interesting for examining the nature of money. I was comparing that chart to federal revenues and expenditures.

It seems that it correlates well with federal tax receipts. In other words, when the YOY change in tax revenues is up so is 0.6*GDP/M2. The two tend to move together

I don't see any similar relationship with federal deficits or spending. Obviously tax revenues and the broader money stock are both related to income and economic activity.

Also I'm not sure I get why you are justified in calling graph #2 the velocity of money. If taxes were raised would that mean less M2 money and would that mean that velocity would increase or would GDP fall by .6*(the added tax) and the velocity remain the same.

I get that if GDP increases without money increasing then the money must be moving faster. But what makes money move faster. I guess some economists view that as being all about 'expectations'.

-jim

The Arthurian said...

Notes from the FRED page on "Velocity of M2 Money Stock (M2V)":

"Velocity is a ratio of nominal GDP to a measure of the money supply. It can be thought of as the rate of turnover in the money supply--that is, the number of times one dollar is used to purchase final goods and services included in GDP."

Whether it is "justified" is another matter. Myself, I think it absurd and dishonest to consider only final spending relative to the quantity of money. But that's what they do, and they call it "velocity".