Money Velocity and the Business Cycle

Abstract

THE SIZE of the supply, currency and bank deposits, is the subject of much comment and discussion. Since much of the Federal Reserve Board policy revolves around the supply, this affects the national economy. Moreover, there are, unavoidably, some political overtones. The velocity of the supply has received scant public attention, which is surprising, since the dollar volume of business done is a product of the amount of and the velocity with which it passes from hand to hand in payment for goods, services and other considerations. The two dimensions of are thus equal partners. Possibly the disparity of attention devoted to them is accounted for by the fact that public policy does have a measure of control over the amount of money, while its velocity is determined more directly by the aggregate of the decisions made by those who own or owe it. Money velocity is the quotient between a measure of business done and a measure of the amount of required. A choice must be made between the numerator and ;the denominator. Most studies have utilized bank clearings or bank debits as the measure of business. This, the author thinks, involves a distortion resulting from periods of high speculative activity. Most measures of velocity, using clearings or debits, find it necessary to omit data for New York City, for which the figures are particularly subject to this distortion. With the development of other stock exchanges, the decentralization of banking and the gradual diffusion of interest in ownership of stocks outside the major financial centers, the distortion may well affect data for other centers. Since this study is oriented toward the business cycle as a whole, rather than toward the speculative aspect of it, a broader and more general measure of business is required. The Gross National Product, or total expenditure for goods and services, meets this need. It is being used in some recent studies in this field, and figures have been reconstructed for an adequate historical period. It reflects the changing level of commodity prices during the years, as well as the volume of goods and services. The choice of a measure of supply is more difficult and possibly controversial. The obvious choice is currency outside of banks, plus either demand deposits, adjusted for Treasury deposits, interbank accounts and un,collected items, or these with the addition of time and savings deposits in banks. The choice is complicated by the fact that various temporary stores of value exist, which, while not being bartered, are normally readily converted into and function as quasi-money. U. S. Savings Bonds, short-term investments, commercial paper, savings and loan share accounts, and credit union balances illustrate these money extenders.' This study excludes these as components of the supply, for three reasons: first, because adequate data are lacking or difficult to assemble; second, because they lack the homogeneity likely to characterize a simpler definition of supply, and third-and most important -because they do not, in fact, pass from hand to hand in transactions entering directly into the production of Gross National Product, but are converted into currency or deposit balances for this purpose.