Whatever Happened To Penny Candy Ch 8

Money Velocity and Inflation

• Velocity is the rate at which money changes hands.
• A dollar traded once a year has a velocity of 1; a dollar traded five times a year has a velocity of 5.
• Velocity is calculated by dividing PQ (the total value of all goods and services traded in a period) by M1 (the money supply).
• A small amount of money can equal many transactions if it changes hands quickly.
• Falling demand for money increases money velocity, leading to faster spending and corresponding price increases (inflation), akin to increasing the money supply.
• Rising demand for money decreases money velocity, akin to decreasing the money supply, reducing spending and price increases.
• Velocity is an effect, not a cause. Demand for money is the cause and velocity is the effect.

Stages of Inflation

• Inflation typically progresses through three stages, each driven by changes in the demand for money/currency.
  • Stage 1: People save money, waiting for prices to fall. Low velocity because the money isn't circulating, and prices can't rise very quickly.
  • Stage 2: Money changes hands faster as people start spending to beat rising prices. Velocity increases as a little money does the work of a lot of money. Prices start rising faster than the money supply is increasing.
  • Stage 3: People spend money quickly to avoid further devaluation, leading to very high velocity. Demand for the currency falls rapidly. People try to convert it to other forms of wealth. The currency loses value rapidly if it is not quickly exchanged or converted.

Controlling Velocity

• Velocity is democratically controlled by individual spending decisions.
• People change spending habits slowly unless triggered by notable events like:
  • Changes in money supply by the government.
  • Government's ability to enforce laws.

Historical Examples and Repeating Patterns

• World War I, 1920: Increased money supply led to a stock market boom, but later the inflation/money supply decrease led to the 1929 crash.
• Roaring 90s: Similar to the 1920s, increased money supply fuelled stock market boom, but did not significantly increase prices of goods and services. This boom also ended in a crash.
• Vietnam (1970s): Government instability caused huge velocity increases, leading to runaway inflation, as the currency lost worth.
• The US (1980s): The government tightened the money supply to combat inflation, leading to the 1980 and 1982 recessions. This brought inflation under control.