Tuesday, July 1, 2014

Velocity and the Context Variable

The measure of all the stuff we produce in a year is called Gross Domestic Product, or GDP. The measure of all the spending it took to produce that stuff is called Gross Domestic Spending, GDS. That's my new name for the context variable I've been developing in the last few posts.

GDP includes final spending. GDS includes final and non-final spending.

When economists speak of "velocity" they mean the number of times the money supply must be spent in order to do all the final spending that happens in a year. But I wonder what use that is. Because if they only count final spending, they only count a small part of the spending that happens. It doesn't make sense.

Type velocity in the search box at FRED, and the first thing that comes up on the list is Velocity of M2 Money Stock. It looks like this:

 Graph #1: M2 Velocity a la FRED
I want to duplicate it.

I downloaded annual numbers for M2 from FRED and used them to plot "velocity" two ways: using GDP for the numerator, as FRED does, and again using my Gross Domestic Spending number for the numerator. Velocity is higher my way:

 Graph #2: The Blue Line of Graph #2 is the Same as the Blue Line on Graph #1 Blue Line: Velocity of Final Spending ... Red Line: Velocity of Final + NonFinal
My blue line shows velocity at about 2 or a little under, just like the FRED graph. My red line shows velocity around 5 or 6 -- that is, 2½ to 3 times higher than the blue. That's what you should expect, as the sum of final and non-final spending is 2½ to 3 times higher than final spending alone.