Velocity of Money - Determination

Determination

The determinants and consequent stability of the velocity of money are a subject of controversy across and within schools of economic thought. Those favoring a quantity theory of money have tended to believe that, in the absence of inflationary or deflationary expectations, velocity will be technologically determined and stable, and that such expectations will not generally arise without a signal that overall prices have changed or will change. This view has been discredited by the precipitous fall in velocity in the Japanese "Lost Decade" and the worldwide "Great Recession" and its aftermath of 2008-10. Monetary authorities undertook massive expansion of the money supplies, but instead of lifting nominal GDP as predicted by this theory, velocity fell as nominal GDP was relatively unchanged.

Some people have incorrectly interpreted velocity to mean the time between receipt of income and when it is spent. Note that how much income is spent helps determine GDP, but when during a pay period it is spent is immaterial. There could be a large volume of spending by people who waited a long time between receiving income and spending it. They could store their income in non-money forms, such as stocks and bonds, between receiving income and spending it. So that notion of "how fast income is spent" is a fallacy.

The view that velocity of money is constant is criticized by Samuelson thus:

In terms of the quantity theory of money, we may say that the velocity of circulation of money does not remain constant. “You can lead a horse to water, but you can’t make him drink.” You can force money on the system in exchange for government bonds, its close money substitute; but you can’t make the money circulate against new goods and new jobs.