Blog von fugaL

Money circulates; it goes round and back, like your blood, or a bad penny. Actually, that saying "it keeps turning up like a bad penny" came about because it used to be that bad pennies literally would pop up over and over again. You'd spend it at the Buy More one day, then another day it's back as change from Burgers Supreme. Nowadays the circulation path of any piece of currency is so large geographically and by number of stops that you don't see it anymore. However, the web site Where's George? lets you track a dollar bill to see where that version of the bad penny turns up.

Even though money paths are now more complex and less circular, money still circulates about all the time. Also like your blood money can circulate at a meager rate as when you sleep, or quickly as during a sprint or horror flick. The measure of how quickly money flows from one hand to another is called money velocity or velocity of money and is measured as a frequency. Intuitively, it describes how often, on average, a single piece of money changes hands in the given time. With a high velocity of money, you would expect that bad penny to turn up sooner rather than later.

Like the money multiplier, money velocity has an effect on the virtual money supply in an economy. If the velocity is 5/yr then on average each dollar is spent 5 times in a year. It was only one dollar, but it's as if there were 5. This is of course different from the money multiplier in that the dollar doesn't exist in two places at once, but rather in two places at two separate times, so the effect is felt in a different way.

Money velocity also plays an important role in the dynamics of the money multiplier. Remember how money multiplies with each successive loan in an infinite series which approaches 1/r? Clearly those successive loans each take time, and $2 billion doesn't become $20 billion overnight. Just how long it does take is inversely proportional to money velocity. A high velocity means that extra $18 billion comes rather quickly, and a low velocity means it trickles in gradually.