A Fragile Global Economy: A falling velocity of money
GLOBAL MACRO INSIGHT
The velocity of money has been falling for many decades. It accelerated to the downside during the 1970s as the world abandoned the gold standard and then remained stable from 1990 to 2008. Reserves (savings) held by exporting nations – for example, Japan, China, and Germany – contributed to the major savings glut since globalization started, contributing substantially to this low velocity of money. After the global financial crisis (GFC), the velocity of money fell below 1, and central banks had no choice but to add to the monetary base to avoid deflation.
This implies that central bank balance sheets will remain a permanent feature of monetary policy as long as velocity of money and policy rates remain this low. Even negative interest rates, which were supposed to force savers to spend, have
failed to boost the velocity of money.
As policy rates approached zero and the velocity of money moved below the important level of 1, the quantum of money and credit in the system became equally important to the price of money.
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