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Slow money growth not necessarily bad (2)

This is a follow-up to my post last month on the same subject. The issue is that M2 money growth has been extremely slow in the past year, as the first chart shows.

As this chart also illustrates, the big slowdown in money growth has coincided almost exactly with the big rise in equity prices. I don't think this is a coincidence. Indeed, I think it is a story that makes perfect sense. This past recession was provoked by an extreme increase in the demand for money, which was expressed in a huge increase in money balances as people cut back their spending and did just about everything they could to increase their money balances. Now that the fear of an international banking collapse has passed, and evidence accumulates that the US and global economies are firmly in recovery mode, the public's desire to accumulate money has gone in reverse. Money is being spent that was hoarded, and money balances are declining.

Declining demand for money has reduced the growth rate of M2, but it has not slowed the economy because declining money demand means that money is being spent at a faster rate, and that is lifting nominal GDP. The next chart illustrates this point quite nicely, as we see that extreme swings in M2 growth tend to coincide with equally strong, but opposite, swings in nominal GDP growth.

Big increases in M2 tend to occur opposite big declines in nominal economic activity, and vice versa. What this means is that the big untold story underlying all this is the velocity of money. M2 velocity (the number of times a dollar of M2 is spent for a given amount of nominal GDP) has been increasing over the past nine months, because M2 growth has slowed way down and nominal GDP growth has picked way up.  That's illustrated in the next chart.

The rise in velocity has been significant, but it is only in its early stages. A better way of describing this is to say that over the past two years M2 increased by an unusually large amount. The money wasn't spent, however, it was stored. Now it is being released, and the stored-up M2 is sufficient to generate some very strong gains in nominal GDP over the next few years.

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