Velocity of Money

Velocity measures how actively money circulates in an economy. If people and businesses spend money quickly, velocity is high. If they hold on to it, velocity is low.

For example, if nominal GDP is 2,000 and the money supply is 500, the velocity of money is 4. On average, each unit of money is used four times a year to buy final goods and services.

Velocity is part of the quantity theory of money, which states that money supply multiplied by velocity equals nominal GDP. If velocity were stable, growth in the money supply would translate directly into growth in nominal spending, and possibly inflation.

In practice, velocity changes considerably. It tends to fall during recessions and periods of uncertainty, when people save more, and when interest rates are very low, since holding money costs little. Velocity in many economies fell sharply after 2008 and again in 2020. This instability is one reason most central banks no longer target the money supply directly.