what this huge spike in the money supply economy means?




In: Economics

M1 is the amount of cash circulating in the economy. Actually it’s cash plus checking accounts and some other things. It shot up because of the stimulus checks and the pandemic in general. The implication is inflation because now you’ve got a larger amount of money chasing around the same amount of stuff.

The velocity of money is how much money changes hands.

The velocity of money collapsed when the lockdowns started happening last year: https://fred.stlouisfed.org/series/M2V

This meant that people stopped buying and selling a lot of things.

In order to compensate for this, the Fed and ECB started engaging in quantitative easing, which increased the amount of money in circulation.

The increase in money supply caused inflation, which countered the deflationary pressure caused by covid.

Deflation is bad because it means that people are better off not spending money than spending, so they reduce spending, which causes recessions to get worse. Because money is now worth more than things, staff have their pay reduced in nominal terms or they are fired. Debts are measured in nominal terms, but money is worth more, so a bigger and bigger portion of peoples’ income has to go to paying debts.

The huge spike means nothing.

As of May 2020, the Fed Changed the definition of M1, to include other liquid assets. Those assets were not counted as part of M1 before May 2020. So, once they changed the definition to include other things, the amount they measured changed.

So it looks like some big increase, but it isn’t. It is an artifact of a changed definition.