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While the amount of money in the system matters, so does the speed at which those dollars circulate.

Chart depicting velocity of money In response to the sharp decline in the economy, the Federal Reserve moved swiftly to make direct purchases of Treasuries, mortgages, and other securities to promote stability and the functioning of those markets. Those actions injected significant liquidity into the system, also causing a sharp increase in the money supply, as illustrated above.

Growth in M2 (a broad measure that includes physical currency, checking and savings deposits, and other highly liquid, noncash assets) is closely monitored as a gauge of the money supply and is viewed as one indicator of future inflation risk. The recent surge in the money supply has raised the specter of inflation once again. The amount of money is only part of the story though; the speed at which money is trading hands — also known as the velocity of money — is equally important. In recent months, consumer spending and business investment have fallen sharply, while the savings rate has surged. The result? Dollars aren’t circulating as quickly, and the velocity of money has dropped sharply. 

Even before the recent downturn, the velocity of money has been slowing since the late 1990s. Inflation has also remained low during that period. In time, the Fed will likely have to reverse course and remove that liquidity to avoid an unwanted inflationary surge. For now though, the risk of rapid money supply growth leading to unwanted inflation is low.

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Data sources for peer group comparisons, returns, and standard statistical data are provided by the sources referenced and are based on data obtained from recognized statistical services or other sources believed to be reliable. However, some or all of the information has not been verified prior to the analysis, and we do not make any representations as to its accuracy or completeness. Any analysis nonfactual in nature constitutes only current opinions, which are subject to change. Benchmarks or indices are included for information purposes only to reflect the current market environment; no index is a directly tradable investment. There may be instances when consultant opinions regarding any fundamental or quantitative analysis may not agree.

Plante Moran Financial Advisors (PMFA) publishes this update to convey general information about market conditions and not for the purpose of providing investment advice. Investment in any of the companies or sectors mentioned herein may not be appropriate for you. You should consult a representative from PMFA for investment advice regarding your own situation.

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