M1 is a measure of money supply that includes physical currency, checking accounts, and other easily accessible deposits. Seasonal adjustments are made to account for regular patterns in the data. M1 refers to three components:
The velocity of money is a measure of how frequently a unit of currency is used to purchase goods and services within a specific time period. It is calculated as the ratio of quarterly nominal GDP to the quarterly average of M2 or M1 money stock. It represents the number of times a dollar is spent on transactions in the economy. When the velocity of money increases, it indicates a higher level of economic activity and more transactions occurring between individuals.
By examining the frequency of currency exchange, we can gain insights into whether consumers and businesses are saving or spending their money. The money supply consists of various components, such as M1 and M2. M includes currency in circulation (notes and coins), demand deposits (checking accounts), and other easily accessible liquid deposits. A decrease in the velocity of M1 suggests a decline in short-term consumption transactions. Short-term transactions refer to everyday spending on goods and services.
The broader M2 component includes M1 as well as savings deposits, certificates of deposit (less than $100,000), and money market deposits for individuals. Comparing the velocities of M1 and M2 provides insights into the pace of spending and saving in the economy.
In summary, the velocity of money measures the frequency of currency usage in purchasing goods and services.
The velocity of Money Supply is highly positively correlated to asset prices. An increase in the rate of money supply is synonymous with a risk-on period or, in other words, an increase in asset prices. On the contrary, a decrease in the velocity of money supply is related to a risk-off period or a reduction of asset prices.
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