Understanding The Velocity of Money

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The velocity of circulation and distribution of money between different types of elements is taken into account by monetarists in the assessments of the health of an economy. In the short term, its value is considered stable, according to the hoarding and payment methods (cash, check, credit card) of economic agents.

The speed (also turnover) of money is the frequency with which the existing money supply is implemented within a year on average. The speed at which many forms of payment circulate is relatively slower than cash, which is used more frequently for payments.

As a universal medium of exchange money must circulate among the economic agents in a currency area. Thus, an economy functions optimally, and the velocity of money remains constant.

According to monetarists, the velocity of money circulation is constant. Similarly to the level of production which is assumed to be constant because of employment of factors relative to production in the economy. Under these two assumptions, any increase in the amount of money increases prices.

This leads to the belief by monetarists that inflation is a purely monetary phenomenon. If there is inflation in an economy, it may be due to excessive money creation disproportional to the level of production of the country. According to the theory of Jean-Baptiste, the real economy would be separated from the monetary sphere.

The currency would have no effect on the level of output of an economy (classical dichotomy). Nowadays, the quantity theory of money is widely accepted in the long term, but in not the case in the short or medium term.

An increase in velocity acts as an increase in money supply which is incremental to the level of prices (inflationary), a reduction in velocity as well as a decrease in the money supply (deflationary).

Under velocity is the ratio of the aggregate sum of money in real transactions (purchases), or an aggregate income variable evaluated for overall money supply. Today the most common form of income velocity at which an aggregate income size – especially the gross national income – is based on the money stock.

Since there are different concepts of aggregate money supply, the various forms of rotational speed also differ according to the measure of money supply.

The equation reflects a simplification compared to the perfectly rigorous equation, which would involve a time integral of the product and the amount money available and its velocity. Implicitly, different forms of money have a characteristic constant velocity over time.



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