Money Supply & Velocity
M1, M2, and how fast money actually changes hands
- Define M1, M2 and explain what each captures
- Explain why velocity matters more than money supply
- Read why 2020-22 QE didn't trigger inflation immediately
The Fed printed trillions in 2020. By textbook monetarism, inflation should have exploded instantly. It didn't — for a year and a half. Then it did. The difference is *velocity* — how fast money actually moves. Get this and the post-COVID inflation story makes sense.
The money aggregates
M1 = the most liquid money: cash + checking accounts. M2 = M1 + savings deposits + small time deposits. M3 (mostly retired) added institutional accounts. The Fed prints reserves; whether they show up as M1 or M2 depends on who's holding what.
Velocity — the missing variable
Inflation = money supply × velocity ÷ output (the quantity theory, simplified). Velocity = how many times each dollar gets spent in a year. If velocity collapses (people hoard, banks don't lend), printing money doesn't cause inflation. If velocity surges, even small money growth can trigger it.
Fed printed massively. Banks parked the reserves; consumers paid down debt. Velocity collapsed. Result: no real inflation for a decade.
Fed printed AND government wrote checks directly to consumers. Velocity recovered as stimulus spent. Result: lagged but brutal inflation 2021-23.
Central bank doubles the money supply but velocity halves at the same time. Likely inflation effect?
- M1 = liquid money; M2 = M1 + savings deposits
- Inflation depends on money supply × velocity
- Velocity collapse can mask money printing for years
- When velocity recovers, the inflation arrives — delayed but real
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