Signals From The Money Supply

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Since the start of the financial crisis the Federal Reserve has grown the money supply with incredible speed.  Inflation hawks have been crying bloody murder.  To be sure, the amount of dollars in the system has increased dramatically.  Since Q1 2005 M1 and M2 have grown about 21% and 30% respectively.  However, this have been offset by a nearly commensurate decline in the amount dollars get around, or velocity.  The charts below show both the growth rates of the money supply as well as the velocity of money since Q1 2005.

Money Supply Growth Rate, Q1 05 through Q3 09:

M1 and M2 Growth Rate

Velocity Growth Rate, Q1 05 through Q3 09:

M1 M2 Velocity Growth

Perhaps the most interesting thing to come out of yesterday’s economic data was that the decline in velocity seems to be coming to an end.  If the trend reverses we are likely to see renewed growth in the price level, which may trigger FED tightening sooner rather than later.

Garrett W. McIntyre