Transactions velocity, Vt, is dependent on many factors, price and income expectations, and the rate at which funds can be transferred, and the legal instruments and regulations which make it possible for people and businesses to economize on their holdings of M1.
Vt is derived from *katallactics* - “the effectuated science of exchanges”. The cumulative effect of katallactics, of structural changes, has been to transform all DFI’s <deposit-taking, money-creating, financial-institutions> time-deposits <savings-investment type accounts> into the economic equivalent of low velocity demand-deposits <basic bank-deposit accounts>, since the holders of these accounts can on demand, or in the marketplace, convert these holdings without significant delay, or loss of income, into demand-deposits.
Transactions velocity is an independent exogenous factor acting on prices and production. Whereas income velocity, Vi, an orthodox and contrived economic figure, a dependent endogenous figure, tells us nothing about the dynamics of money flows - because it measures neither the volume, or RoC <rate-of-change> of actual money flows. It is real means-of-payment money exchanging hands that affect price-levels, price trends, interest rates, employment, production, etc.
All the devices which have in effect made DFI time-deposits an integral part of demand-deposits, viz., daily compounding of interest (a dominate decision driver reducing transfer costs), automatic fund transfers (speeding the execution of transfers), etc., have enabled people and corporations to economize on demand-deposits, esp. since 1967.
Brokered CDs, the commercial paper market, banker’s acceptances, and other “negotiable” money-market securities, e.g., synthetically engineered asset products (collateralized debt obligations, securitized new money substitutes), as well as ATS-accounts, sweep-accounts, and ETFs, and some aggregates formally included in the Fed’s money aggregate “L”, have enormously accelerated the exchange of both: (1) money products, and (2) savings’ products.
Even the development and evolution of the Treasury bill, gov’t securities repo market, agency securities market, and international E-$ securities has made it possible and profitable for any firm having an excess cash balance to loan it to their banks which in turn can loan the funds in the money market overnight (as today measured by OBFR, ”the overnight bank funding rate, calculated as a volume-weighted median of overnight federal funds transactions and Eurodollar transactions reported in the FR 2420 Report of Selected Money Market Rates). And there are other devices that enable corporate treasurers and portfolio asset managers to economize on their holdings of cash: concentration, pooling, and management.
The increasing availability and affordability of goods and services for consumers after WWII provided the original impetus to rising money velocity (the expansion of transaction units, T, in American Yale Professor Irving Fisher’s truistic “equation of exchange”, the expansion of real-output, conventionally expressed as ‘Y’ on Milton Friedman’s car license plate, or R-gDp).
About the time these factors had reached a plateau, a whole series of structural changes were introduced which enabled money holders to minimize checking account balances (aka Alfred Marshall’s cash balances explication, #1, motives for holding liquid cash balances rather than non-monetary assets).
The process of monetizing time (savings) deposits within the payment's system began in the early 1960’s with Citicorp’s Walter Wriston inventing the negotiable CD - which drew funds out from all over the world, indeed from the international, unregulated, E-$ banking market (with an ever-mounting and inflationary, self-reinforcing depreciating currency effect, as the volume of E-$s directly impacts U.S. prices).
Wriston “presided over an encyclopedic range of innovations - among them negotiable CDs, term loans, syndicated loans, floating-rate notes and currency swaps-that ended forever the moribund banking of the 1950s and ushered in our razzle-dazzle age of finance” #2. Wriston “masterminded the bank’s explosive change from stagnant deposit-and–loan institutions to a global purveyor of financial resources.” Consequently, banks began to manage their liabilities, and corporations began managing (minimizing) their non-interest-bearing cash balances. Consequently, banks began systematically, to buy their liquidity, instead of following the old-fashioned practice of storing their liquidity.
Increased use of, and faster air traffic, speeded up the time for checks and clearing balances to be credited to the receiving banks, and the Fed further abetted the process by reducing “float” time to a maximum of two days (similar to the productivity enhancements from “Check 21” services on October 28, 2004). The culmination of this speeding up process came with the introduction of electronic clearing (the epochal supplanting of clerical hand-held processing, e.g., lockbox processing, the closest collection and remittance processing of account receivables, viz., the robotized on-line, real-time, immediate streaming of economic activity, e.g., new technology utilizing OCR and data validation.
Velocity was given a further upward push by the introduction of ATS accounts (automatic transfer of savings, performed without delay or income penalty of withdrawal), removing the explicit demarcation between transaction and savings-investment type accounts since Great Depression banking reforms, like the Glass-Stegall Act (Section 11(b), authorized the Federal Reserve Board to limit interest rates on time deposits), preventing economists from isolating money intended for spending, from that money held as savings. The distinction was considered important because only money that is spent, proffered “true money” (our means-of-payment money) – influences P and T. This dilemma is resolved when Vt is considered; i.e., M1 is analyzed in terms of flow: M*Vt. It is obvious that money has no significant impact on prices unless it is being exchanged.
The plateau in transactions velocity, the “S-Curve” event dynamic damage (sigmoid function), occurred because of the saturation in new bank deposit classifications in the 1-2 quarters of 1981 (fulfilling the prediction of an imminent 1981 time-deposit “emancipation”, from the interstate ratification of ATS, NOW, SuperNOW, and MMDA deposit reclassifications).
Stephen Goldfeld labeled this type of disparity: “instability in the demand for money function” as a “case of the missing money”, whereas it was simply related to, e.g., the “monetization” of commercial bank time deposits (ending gate-keeping restraints), all of which occurred within the payment’s system (producing a step-up in Vt). It supposedly “presented a serious challenge to the usefulness of the money demand function as a tool for understanding how monetary policy affects aggregate economic activity.”
This one-off inflection was discussed on the FRB-NY’s website: “Following the introduction of NOW accounts nationally in 1981, however, the relationship between M1 growth and measures of economic activity, such as Gross Domestic Product, broke down. Depositors moved funds from savings accounts—which are included in M2 but not in M1—into NOW accounts, which are part of M1. As a result, M1 growth exceeded the Fed's target range in 1982, even though the economy experienced its worst recession in decades.”
Transactions velocity data reveals a sharp uptrend since 1965. The annual rate of turnover of money in 1965, for example, was 35. 17 years later, it was 216 in December 1981. One dollar of DDs added to the money supply in 1981 obviously had an annual monetary “punch” on prices over five times greater than a dollar fed into the economy in 1965. It bears repeating: It is money flows relative to the flow of goods and services, not money standing alone, that determines the price level and over time the rate of inflation or deflation.
15 years later, Vt was 525 in September 1996 (when the G.6 Debit and Demand Deposit Turnover release was finally discontinued, at that time, the BOG’s longest running “time-series”), slowing to 1.5 times greater in a comparable time frame (significantly 3.6 times slower after the 1981 inflection point).
The sharp increase in DD velocity since 1965 was the consequence of a variety of exogenous derived factors which include:
1) the daily compounding of interest on savings accounts in commercial banks and “thrift” institutions (Saving and Loan Associations, Credit Unions, and Mutual Savings Banks),
2) the increasing use of electronics to transfer funds (ETF accounts)
3) the introduction of “negotiable” commercial bank certificates of deposits,
4) the rapid growth of ATS (automatic transfers of savings to DDs) and NOW (negotiable orders of withdrawal) accounts, and MMDA (money market deposit accounts)
...all which enabled people to economize on demand deposits (exploit opportunity costs)
5) in combination with these factors, higher interest rates are both a cause and an effect of higher turnover rates, thus contributing to the publics’ desire to minimize noninterest bearing checking accounts. By forcing up rates of inflation – and thereby interest rates, the public is induced by the higher interest rates, and by expected higher prices, to minimize its holdings of non-interest- bearing demand deposits.
During this inevitable 1966-1981 stagflationary era (an outlier), there was an excessive increase in both the volume and velocity of money. The volume of money expanded consequent to the FRB-NY’s trading desk’s policy blunder, using interest rate manipulation, beginning in 1965, viz., the Fed Fund’s “bracket racket”, creeping policy rate peg pressures on the upper side of the bracket, which were tantamount to using a price mechanism to ration Federal Reserve bank credit (credit allocation on a price basis).
As late as 1956, member banks were paying an average rate of only 1.5 percent on their time deposits. The Fed capped the interest rate member banks could pay through its Regulation Q, and the FDIC followed the practice of applying the same rate structure to all insured nonmember banks.
Because of the unprecedented housing boom following WWII the Savings and Loan Associations prospered and grew; and at a much faster rate than the commercial banks. This intensified the desires of the commercial banks to “get a piece of the action”.
Because of the Fed’s pegging policy on the federal funds rate, go-for-broke bankers knew that to obtain additional legal reserves, bank legal lending capacity, they could go into the federal funds market, bid up the policy rate (usurping the Fed’s “open market power), and the Fed would respond with net open market operations. This they did, all the while agitating for higher and higher interest rate ceilings; and the Fed, and consequently the FDIC, accommodated them. Thus, more and more debt was monetized, and the inflationary consequences pushed inflation and interest rates to double digit levels.
The crescendo in DD Vt in the 1st qtr. of 1981 coincided with peak in AD, N-gDp, and interest rates. It presaged a protracted deceleration in money velocity.
bit.ly/2udPcXw.
Notably, under the institutional arrangements prior to 1981, an increase in time deposits resulted in an offsetting increase in transactions velocity – therefore no dampening economic impact resulted. If there is to be an increase in time-deposits, there should be as offsetting increase in money velocity (otherwise frozen savings, monetary stocks which are un-used and un-spent, slow Vt, reducing aggregate demand, AD, and shrink its subset: N-gDp).
Keynes’ “liquidity preference curve” concept (demand for money), assumes an infinite math progression. In the real world, it didn’t work out that way [the stoppage in the flow of funds wasn’t ultimately, entirely compensated for, as Lester V. Chandler originally theorized – “by an increased velocity of the remaining bank deposits” #4] Princeton Professor Dr. Lester V. Chandler, Ph.D., Economics Yale, theoretical explanation was in 1961:
“that monetary policy has as an objective a certain level of spending for gDp, and that a growth in time (savings) deposits involves a decrease in the demand for money balances, and that this shift will be reflected in an offsetting increase in the velocity of demand-deposits, DDs.”
His conjecture was correct up until 1981 – up until the saturation of financial innovation for commercial bank deposit accounts. I.e., the saturation of DD Vt according to Dr. Marshall D. Ketchum, Ph.D. Chicago, Economics:
"It seems to be obvious that over time the “demand for money” cannot continue to shift to the left as people buildup their savings deposits; if it did, the time would come when there would be no demand for money at all”
Thus, as Dr. Leland J. Pritchard, Ph.D. Chicago – Economics 1933, M.S Statistics, Syracuse predicted immediately after the passage of (1) the DIDMCA of March 31, 1980, coinciding with his prediction of the (2) the emancipation of time-deposits, viz., the 1981 "time bomb", that money velocity had reached a permanently high plateau.
Professor emeritus Pritchard never minced his words, and in May 1980 pontificated that:
“The Depository Institutions Monetary Control Act will have a pronounced effect in reducing money velocity”.
The rise in demand deposit velocity was largely due to certain institutional innovations. All of these were introduced in a revolutionary period. They included the introduction of new negotiable credit instruments, new non-bank money substitutes (near monies), e.g., the proliferatation of repurchase agreements; the reduction or elimination of all interest ceilings and reserve ratios on all types of time and savings deposits in the payment’s system and the propagation of un-gated bank accounts (a precursor to Alan Greenspan abdicating the Fed’s power to control money flows through binding required reserve restraints in order to counteract the 1990-1991 economic recession).
Reserve and regulatory avoidance, deposit reclassification via financial innovation, aka overnight retail and wholesale sweep programs resurfaced in a temporary Vt trend reversal during 1990’s - “just an accounting technique…a cash account used to make scheduled payments, and an investment account where the cash is able to accrue a higher return”.
Since it is unlikely that these innovations will be reversed or eliminated, or new ones introduced that will add significantly to the velocity of demand deposits, as now delineated by “total checkable deposits”, it is probable that demand deposit velocity will increase, if at all, at sharply diminishing rates.
The effects of institutional innovations, plus application of electronic technology in the transfer of funds have probably exerted their maximum, or near maximum, impact on DD Vt. Consequently, it seems probable that future monetary contributions to inflation will be confined largely to increases in the volume of DDs, subduing future inflationary pressures.
Since these structural changes have now reached “maturity” the rate of increase of Vt has tapered off, and there may be other factors associated with a declining economy that could result in an absolute decrease in Vt.
The recent warped distribution of securities tendered on the front end of the yield curve, and term structure flattening, is chiefly influenced by Vt; Vt is chiefly influenced by the impoundment of monetary savings; Vt is influenced by katallactics.
This begs a syllogistic inquiry. If the growth of the M2 money stock is not due to DFI credit expansion, or not due to an expansion of currency held by the nonbank public, but merely reflects the shifting of the deposit accounts into those categories included in non-M1 components, as a larger proportion of a larger volume of money becomes interest bearing (Keynes’ liquidity preferences #3, the orthodox interpretation of the “demand for money”), then unexpectedly, money velocity demonstrably slows.
This stock vs. flow, backwardation (inverted prices) vs. contango (rising prices) clears up QE’s contrary forces: first rising rates, then falling rates; and FOMC schizophrenia: Do I stop - because inflation is increasing? Or do I go - because R-gDp is falling?
The impact of any shift in the DFI’s liabilities was altered in 1981, from an accelerated turnover of deposits, bank debits or demand drafts to those accounts (money actually exchanging counterparties), in both (1) total checkable deposit classifications in M1, and in (2) savings-investment type accounts in non-M1, during the historical pattern and subsequently forgotten “monetization of time deposits“ (the relaxation of structural gate-keeping restrictions - legal and administrative), in the 1960-1981 period.
The warp in N-gDp (stretch and squeeze) is predominately being driven by changes in Vt. Japan is a textbook case. Changes in Vt are largely determined by an increasing percentage of monetary savings being impounded and ensconced within the confines of its payment’s system. This is the direct cause of secular strangulation, chronically deficient aggregate monetary purchasing power, AD. Low interest rates are a reflection of this stagnation, generating an excess of savings over investment outlets.
Like I observed:
The interest-bearing character of the DFI’s deposits which results in any sudden larger proportion of commercial bank deposits in the interest-bearing category destroys money velocity.
fred.stlouisfed.org/series/CD12NRNJ2018-11-05 0.49
2018-11-12 0.49
2018-11-19 0.56 [spike]
2018-11-26 0.57
This is also an excellent device for the banking system to reduce its aggregate profits.
It is hard for the average person to believe that banks do not loan out savings or existing deposits – demand or time. But the DFIs always create money by making loans to, or buying securities from, the non-bank public.
This results in a double-bind for the Fed. If it pursues a rather restrictive monetary policy, e.g., QT, interest rates tend to rise.
This places a damper on the creation of new money but, paradoxically drives existing money (savings) out of circulation into frozen deposits (un-used and un-spent). In a twinkling, the economy begins to suffer.
% Deposits vs. large CDs on "Assets and Liabilities of Commercial Banks in the United States - H.8"
Jul ,,,,, 12227 ,,,,, 1638.6 ,,,,, 7.46
Aug ,,,,, 12236 ,,,,, 1629.4 ,,,,, 7.51
Sep ,,,,, 12268 ,,,,, 1662.4 ,,,,, 7.38
Oct ,,,,, 12318 ,,,,, 1685.8 ,,,,, 7.31 (twinkling)
Nov ,,,,, 12313 ,,,,, 1680.1 ,,,,, 7.33
Dec ,,,,, 12425 ,,,,, 1698.6 ,,,,, 7.31
Jan ,,,,, 12465 ,,,,, 1732.9 ,,,,, 7.19
Feb ,,,,, 12494 ,,,,, 1744.6 ,,,,, 7.16
Convergence of spot to futures (rise in bonds, fall in stocks) is underway.
-Michel de Nostredame
#1 Alfred Marshall: “Money, Credit, and Commerce” (London: MacMillan, 1923)
#2 The “Go-for-Broke Banker” Ron Chernow’s review of: Phillip L. Zweig’s “Wriston” (Crown, 952 pages)
#3 John Maynard Keynes: "The General Theory of Employment, Interest and Money", pg. 81 (New York: Harcourt, Brace and Co.)
#4 “Should Commercial banks accept savings deposits?” Conference on Savings and Residential Financing 1961 Proceedings, United States Savings and loan league, Chicago, 1961, 42, 43.
See: John Tatom: "Was the 1982 velocity decline unusual?"
See: Stephan M. Goldfield, Princeton University “The Case of the Missing Money”
See: Philip George: “The velocity of money is a function of interest rates”
Addendum:
K (the length of the period over whose transactions purchasing power in the form of money is held) under certain conditions in Alfred Marshall’s “cash balance” equation may be regarded as the reciprocal of Vt [which is a function of the volume of cash held and the level of prices]. And M is a “schedule,”, and not a “quantity” as in the transactions-velocity approach.
The one element binding the motives of individuals and firms for holding cash balances is the element of uncertainty. All the motives which induce the holding of a larger volume of money will tend to increase the demand for money – and reduce its velocity. Interest rates are function of money flows, debits to deposit accounts, or the transactions velocity - Vt, of money.
Alfred Marshall's cash-balances approach (viz., a schedule of the amounts of money that will be offered at given levels of "P"), viz., where at times "K" is the reciprocal of Vt, or “K” has the dimension of a “storage period” and "bridges the gaps of transition periods" in Yale Professor Irving Fisher’s model.
In Alfred Marshall’s “Cash-Balances Approach” to the value of money, the same motives which induce the holding of a larger volume of money will tend to increase the demand for money – and reduce its velocity, for example – uncertainty, irregular income receipts, when prices are expected to fall, etc.
So “K”, the length of the period over whose transactions the public holds purchasing power in the form of money, their “holding period”, will be larger. Thus, low interest rates may induce people to hold onto their funds and not part with liquidity for such a small price. This will also tend to reduce the supply of funds and their velocity.
