Is the Velocity of Money Signalling That There Will Be No Price Inflation?

Via Economic Policy Journal

Despite the super-aggressive money printing by the Federal Reserve, I am beginning to see a number of economists, sympathetic to Chicago School monetary thinking, playing down the potential of a strong spike up in price inflation “because the velocity of money is falling.”

First off, the concept of the velocity of money is, to put it mildly, a bit rough around the edges (SEE: Man, Economy, and State: With Power and Market by Murray Rothbard pp. 831-842).

But to allow this problem to pass for the moment, one has to then ask: Why wouldn’t the velocity of money be declining now, given the lockdown?

It is not like there are vast sectors where money can be spent. Indeed, many of the areas that are currently open have sticky prices.

For example, under current conditions, even if new money is pumped into individuals’ wallets, it won’t mean that rents will necessarily be going up immediately. Rent prices are, especially under current conditions, very sticky.

If we have an economy that consists of, say,  rent payments and ice cream buying and ice cream buying is locked down, then it is very possible for the velocity to decline under a lockdown.

However that says nothing about price inflation once the restrictions on ice cream selling are lifted. If restrictions are removed and everyone goes back to buying ice cream and everyone has more Fed money in their pockets, then the money spent on ice cream could very well go up–and the price of ice cream.

READ ALSO  Nordstrom Tells Landlords To Expect Just Half Their Rent Until January 2021

Further, if at the same time, there are supply shocks where less ice cream is available in the market than before the lockdown, you could have price pressures from both more dollar demand and less supply.

I also hasten to point out that it is possible for prices to go up when the velocity is declining if enough new money is in the system.

Let us go back to our ice cream example, if we assume that the money supply has increased by 10%  and that the cost of an ice cream with cone before the lockdown/money pump was $3.00, then we can say that buyers could now pay $3.30 for an ice cream with cone to keep the same price-money supply ratio.

But it is entirely possible that consumers, in general, would only be willing to bid $3.05 for ice cream with cones. This would result in price inflation but also a decline in velocity.

In other words, if dollar bidding only uses a small fraction of a money supply expansion above previous dollar demand, then you would have a case of increasing prices plus falling velocity.