#Zombie spend money and trash it series#

If you assume that velocity is fixed in the short-run, then higher money supply would mechanically lead to a higher GDP. Velocity of Money is just GDP / Money Supply, which can be rearranged as GDP = Money Supply x Velocity of Money. In this framework, the mechanism through which the increased quantity of money leads to higher short-term economic activity is a concept called the Velocity of Money. Monetarists view inflation and growth through the lens of the quantity of money – where higher quantities of money spur temporary increases in short-term real growth as people spend more, but eventually prices adjust and all you are left with is higher longer term inflation.

You may have heard of Milton Friedman’s famous quote “ Inflation is always and everywhere a monetary phenomenon,” a quote that encapsulates the viewpoint of monetarists. There is no justification in thinking that velocity will eventually rises, leading to higher GDP growth on account of the larger M2 money stock. It is not stable because 1) its measurement does not include transactions that do not contribute to GDP, and 2) it’s affect by technological changes. It cannot be used to link money supply to GDP.

Basically, the velocity of money is a useless concept because it is not stable nor mean reverting. I will draw heavily from a excellent recent IMF paper on the subject by central banking expert Peter Stella et al. Today’s installment of Zombie Concepts features the velocity of money – a concept often discussed but easily shown to be useless.

#Zombie spend money and trash it series#

In this series I will talk about dead macro concepts that refuse to die.