I explain the problems by first starting with a very simple idealised economy in which money velocity is well-defined and is perhaps somewhat useful. I then add complications that appear in the real world which make velocity effectively impossible to measure....Bond Economics
Why We Cannot Measure Money Velocity Directly
Brian Romanchuk
http://www.bondeconomics.com/2021/11/why-we-cannot-measure-money-velocity.html
A quote from Richard Werner (New Paradigm in Macroeconomics: Solving the Riddle of Japanese Macroeconomic ...).
ReplyDeleteSolving the enigma of the ‘velocity decline’
The problems arising from the implicit assumption that nominal GDP (that is, PY) can be used to represent total transaction values (PT) are obvious. GDP transactions are a subset of all transactions. The mainstream quantity equation (2) that uses income or GDP to represent transactions will thus only be reliable in time periods when the value of non-GDP transactions, such as asset transactions, remains constant (thus dropping out when considering flows). However, when their value rises, this will cause GDP to be an unreliable proxy for the value of all transactions. In those time periods we must expect the traditional quantity equation, MV ⫽ PY, to give the appearance of a fall in the velocity V, as money is used for transactions other than nominal GDP (PY). This explains why in many countries with asset price booms economists puzzled over an apparent ‘velocity decline’, a ‘breakdown of the money demand function’ or a ‘mystery of missing money’ – issues that severely hampered the monetarist approach to monetary policy implementation. Spindt (1985), Allen (1989, 1994), Howells and Biefang-Fisancho Mariscal (1992) and Werner (1992, 1997d) explicitly argue that the widely observed velocity decline is not due to ‘disintermediation’, financial innovations or
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structural issues such as deregulation, as the literature has argued, but instead is the result of an increase in transactions that are not part of GDP (see also Akabane, 1997). Besides financial transactions, the majority of real estate transactions are equally not part of the GDP statistics (Werner, 1992).
Of course, with the increase of non-GDP transactions due to financial engineering, a result of the historically low interest rates, velocity declines as it must by arithmetical necessity.