What is velocity of money?

Velocity of money measures how fast money circulates through purchases. It matters because the same amount of money can support more or less spending depending on how often it is used.

How it works

The standard identity is M times V equals P times Q, where M is the money supply, V is velocity, P is the price level and Q is real output. Nominal spending P times Q equals the money stock times how often it turns over. If people hold on to cash, V falls and the same money supports less spending.

Velocity moves with confidence, interest rates and payment habits. When people expect prices to rise, they spend faster, V rises, and prices can rise more. When people are afraid, they hoard, V falls, and the economy can slow even if the money supply is unchanged.

Example

Say an economy has a money supply of 1,000 and total yearly spending of 5,000. Velocity is 5,000 divided by 1,000, which is 5. If fear leads people to spend more slowly, so that each unit changes hands 4 times a year, spending drops to 4,000 with the same money. To bring spending back to 5,000 with V at 4, the stock would have to reach 1,250. The numbers are an illustration.

How to model it in Machinations

Create a Pool for money in circulation and a Converter that moves it into spending each step at a rate given by a velocity Register. Spending flows to a Pool of income, which flows back as money. Add a Lever for how eagerly people spend and a state connection from expected prices to velocity. Play with the Lever high and low, and chart spending to see how the same money produces different activity.