Velocity of circulation of money is part of the the Monetarist explanation of inflation operates through the Fisher equation:
M x V = P x T
M = Stock of money
V = Income Velocity of Circulation
P = Average Price level
T = Volume of Transactions or Output
For example if M=100 V=5 P=2 T=250. Therefore MV=PT – 100×5 = 2×250. Both M x V and P x T are equivalent to TOTAL EXPENDITURE or NOMINAL INCOME in a given time period. To turn the equation into a theory, monetarists assume that V and T are constant, not being affected by changes in the money supply, so that a change in the money supply causes an equal percentage change in the price level.
However when the velocity of money in the US is falling, monetary policy which would otherwise cause inflation doesn’t seem to do so. The velocity of money fell 17.7% in 2020 with velocity for the year averaging an estimated 1.2, the lowest level since 1946 (see chart above). With less money going around the circular flow this frees up what available funds people have for financial investment which put up prices in asset markets especially in the housing market. However this money is with the higher income groups.
We have no idea of how the future is going to unfold because we have never seen anything like this before – to quote Rogoff and Reinhart – This time it is definitely different.
Source: Hoisington Investment Management – Q4 2020