The velocity of money is the rate at which people spend cash. Think of it as how hard each dollar works to increase economic output. When the velocity of money is high, it means each dollar is moving fast to purchase goods and services. It reflects high demand, which generates more production.

When the velocity is low, each dollar is not being used very often to buy things. Instead, it's used for investments and savings. This low demand doesn't generate as much production.

What Is the Velocity of Money?

The velocity of money is how often each unit of currency, such as the U.S. dollar or euro, is used to buy goods or services during a period.﻿﻿ The Federal Reserve describes it as the rate of turnover in the money supply. ﻿﻿

Formula

The velocity of money is calculated by dividing the nation's economic output by its money supply. It uses this equation.

V = PQ/M Where: V = Velocity of Money PQ = Nominal Gross Domestic Product M = Money Supply

Nominal Gross Domestic Product

Gross domestic product (GDP) measures everything produced by all the people and companies within a country's borders. Nominal GDP measures this output without adjusting for inflation. To calculate the velocity of money, you must use nominal GDO because the measure of the money supply also does not account for inflation.

Money Supply

Central banks use either M1 or M2 to measure the money supply.﻿﻿ M1 includes currency, travelers' checks, and checking account deposits (including those that pay interest.)

M2 adds savings accounts, certificates of deposit under $100,000, and money market funds (except those held in IRAs). The Federal Reserve uses M2 since it's a broader measure of the money supply.

Neither M1 nor M2 includes financial investments, such as stocks, bonds, or commodities. They also don't include home equity or other assets. These financial assets must first be sold before they can be used to buy anything.

If you use your debit card, that affects the money supply. It directly transfers money from your checking account to the vendor.

The money supply does not include credit card purchases or amounts.﻿﻿ Credit cards aren't a form of money, although they are used as such. Instead, they are a form of debt. The credit card company loans you the money to make the purchase. When you pay it back from your checking account, then that affects the money supply.

U.S. Velocity of Money

The U.S. velocity of money was 1.427 in the fourth quarter of 2019. That means a dollar was used 1.427 times in the past year.﻿﻿

That's its lowest level since at least 1960. It means families, businesses, and the government are not using the cash on hand to buy goods and services as much as they used to. Instead, they are hoarding it, investing it, or using it to pay off debt.

Velocity of Money Chart

This chart shows you the decline in the velocity of money since 1999. It also shows how the expansion of the money supply has not been driving growth. That's one reason there has been little inflation in the price of goods and services. Instead, the money has gone into investments, creating asset bubbles.