Is Velocity Stifling Inflation Amid Record Growth of Money Supply?

January 05, 2021 | Evan Frazier, CAIA, Research Analyst, U.S. Equities

Line chart showing M2 Money Stock in teal and Velocity of M2 Money Stock in green. Chart subtitle: M2 continues to grow while money velocity dips. Chart description: Left Y-axis shows $ in billions, ranging from 0-$20,000. Right Y-axis shows Velocity from 0.0-2.5. X-axis shows time since January 2000, through August 2020. Recessions are marked by shaded grey bars, denoting the dot-com bubble in the early 2000s, the Global Financial Crisis in 2008, and the current recession which began in March 2020. M2 Money Stock line begins near $4,000 in January 2000 and is currently near $19,000. Velocity line begins near 2.0 in January 2000 and is currently near 1.2. The two lines converged around October 2015. Recently the M2 Money Stock has climbed sharply and Velocity dipped significantly in 2020 but most recently slightly grew. Chart source: Federal Reserve Bank of St. Louis as of December 31, 2020.

Inflation has remained well below 3% in the United States for nearly a decade despite a record economic expansion and supportive monetary policy. Even after unprecedented alterations to the macroeconomic landscape in recent months, investors have not seen the significant price level increases that might have been expected in theory. This puzzling situation may be at least partially explained by the current relationship between money supply and velocity.

When it comes to economic relief efforts in the U.S. during 2020, no entity has been more active than the Federal Reserve, which has increasingly relied on open market operations with short-term interest rates near zero. Since the start of the pandemic, the Fed has purchased $3.5 trillion in Treasuries, corporate bonds, and mortgage-backed securities, and recently announced its intention to press forward with $120 billion per month in additional bond buying. The central bank’s balance sheet has now ballooned to over $7 trillion. As a result, M2 ­— a measure of the total money supply that includes narrow money, cash equivalents, and short-term deposits — spiked by roughly 25% in 2020, a record year-over-year growth figure.¹ The recent M2 surge has been accompanied by a decrease in the velocity of money, calculated as the ratio of quarterly nominal GDP to the quarterly average of M2 money stock. Put simply, velocity denotes the rate of turnover in the money supply and is a gauge of economic health, as higher velocity is usually associated with more robust economic activity. Since the beginning of 2020, money velocity has fallen by more than 20%, indicating a strong preference for saving vs. spending on the part of the American consumer since the outbreak of COVID-19.

The relationship between money supply and velocity has significant implications for security markets going forward, particularly as it relates to inflation. Investors have long been confounded by the absence of inflation in the U.S. since low interest rates and M2 growth should lead to higher price levels all else equal. Part of the reason for the lack of inflation could be lower levels of money velocity, which has largely declined since 2000 amid three significant recessions in the United States. The recent plunge in velocity may signal to central bankers that expansionary efforts could be continued in the near term without the risk of significant price level increases. As the economic recovery continues, however, velocity will necessarily rise, which could lead to interest rate hikes and the tapering of the Fed balance sheet to prevent runaway inflation. Investors should be cognizant of the possibility of restrictive monetary policy in the coming years as the world lifts itself out of recession.

Print PDF > Is Velocity Stifling Inflation Amid Record Growth of Money Supply

¹As measured on November 30, 2020


The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Evan Frazier, CAIA
Research Analyst, U.S. Equities

Get to Know Evan

Related Content

Column/line chart showing PE fund size step-ups and increased fund sizes. Chart subtitle: Private equity fund size step-ups have remained consistent over the last decade. Chart description: Left y-axis ranges percent from 0-100%. X-axis goes by years from 2007 to 1H2021. Columns in purple show % PE Funds Raising Greater Fund Size; line in gray shows Median % Fund Size Step-Up. Ranges for both categories are fairly consistent; columns hover near 70% and line has larger range but has hovered between 30% and 51% for the past ten years. The lowest year for both categories was 2010, with 65% and 22% respectively. As of 1H2021, 72% of PE funds are raising greater fund sizes and the median fund size step-up is 48%. Chart source: Pitchbook 2Q 2021 U.S. PE Breakdown.


Private Equity Staying Rational with Fund Sizes

Despite strong fundraising numbers in recent years, private equity managers in the U.S. have stayed consistent with subsequent fund size…


Have Things Been Too Quiet?

Although this is only the second iteration of my quarterly letter series, Marquette has always produced quarterly market narratives in…


2021 Halftime Market Insights Video

This video features an in-depth analysis of the first half of 2021, reviewing general themes from the second quarter and…

Two charts showing private equity exit activity. Chart subtitle: PE exits and exits via IPO have increased meaningfully YTD. First chart description: Left y-axis for columns shows PE exits by billions of dollars, ranging from $0-450. X-axis shows years 2011-H1 2021. Right y-axis for line shows exit count ranging from 0-1400. 2021 so far has had 676 exits at a value of $356 billion, on pace to beat the records of 1328 exits in 2015 and $421 billion in exit value in 2018. Second chart description: Stacked column chart showing percentage of exits by type from 2011 through H1 2021. At bottom of each column, corporate acquisition, middle category is public listing, and top of column is sponsor acquisition. 2021 has seen a significant increase in public listings so far. Note: Latest available 3Q20 Federal Debt as % of GDP used as proxy for 4Q20 Federal Debt as % of GDP. Chart source: PitchBook; U.S. data as of June 30, 2021.


PE Tapping Public Market Strength

Private equity exits are set to break record numbers in 2021. In 2020, there were 947 exits worth $367 billion,…


Welcome Back…to the Grind

Uncertainty lingers in the office sector against a backdrop of extended office closures across the U.S. Average occupancy rates have…

Line chart showing lumber price level in teal. Chart subtitle: Lumber prices have sharply corrected from the early May peak. Chart description: Y-axis shows USD per Thousand Board Feet, a range of $0-$1,800. X-axis shows time, from July 2017 to present, in increments of two months. Up to about August 2020, prices hovered between $300 and $700, but increased dramatically through last autumn and into 2021. Prices peaked in May at over $1600 but have since corrected to about $790. Chart source: Bloomberg as of July 2, 2021.


The Lumber Experience

“The lumber experience,” as coined by Federal Reserve Chair Jerome Powell, has become the poster child for transient inflation. After…

More articles

Subscribe to Research Email Alerts

Research Email Alert Subscription

Research alerts keep you updated on our latest research publications. Simply enter your contact information, choose the research alerts you would like to receive and click Subscribe. Alerts will be sent as research is published.

We respect your privacy. We will never share or sell your information.

Thank You

We appreciate your interest in Marquette Associates.

If you have questions or need further information, please contact us directly and we will respond to your inquiry within 24 hours.

Contact Us >