Inflationary expectations lead to a higher ratio of the velocity of money while deflationary and dis-inflationary expectations lead to a lower ratio of the velocity. The countermovement of the velocity can change an increase of the stock of money into a contraction or turn a monetary contraction of the stock into an expansion. Whatever the aggregate used, the velocity of money can strengthen or weaken the effects of a change of the amount of money. When M1 is used, the question is by which factor circulating cash and deposits multiply into nominal national income.
In the first case, the definition answers the question by what factor the amount of base money transforms into nominal gross domestic product. To determine the velocity of money, the monetary authorities use various aggregates such as the monetary base or the monetary stock M1 (cash and deposits) or the wider aggregates M2 or M3 as references. One unit of money serves for several transactions over time.īecause “money” is not a definite term, the dimension of the stock of money depends on the definition of the aggregate. The velocity of the circulation of money refers to the frequency of the monetary transactions in an economy. The weak link in monetary policy is the connection between money as a stock and money in circulation, the so-called velocity of money.
