Wednesday, May 30, 2012

Are Market Monetarists Right? Part 2

So M2 velocity fell off a cliff around 2008 and has not recovered; the chart in the previous post demonstrates that. For fun, lets review Fisher's Equation of Exchange that gives us a relationship between the money supply, velocity, the price level, and real income:

                                                                      M * V = P * Y
The left hand side of the equation gives us nominal spending and the right hand side nominal income. Holding everything else constant, a fall in V would give us lower P * Y or lower nominal income, i.e. a recession. To avoid that, we expect the Fed to do what is does best... conduct open market operations to expand the money supply M (in this case we're looking at M2). So how much has the Fed expanded M2 in the face of the decline in V? 

Ummm, pardon me, but does anyone else notice how the M2 money supply seems to have been held rather... stable? I mean, stable along its previous trend path? Given the algebra of M * V = nominal spending, looking at these charts I'm thinking some faster M2 growth to compensate for the fall in V would do wonders for our nominal GDP- and hence real GDP and employment, given our assumptin of wage and price nominal ridgitity... more on this later. 

1 comment:

  1. MV doesn't equal PY. MVt=PT Vt has steadily increased ever since March 2009.