Monday, February 9, 2009

The Velocity of Money

The battle is being fought in Washington now about how huge the amount of money we should have in the Stimulus Package in order to get the economy back on the recovery track. Perhaps more important than the amount of money is the character of the projects we are going to tackle with this money. I'm not trying to nit-pick the specific projects; the politicians have already done that, and neither side is completely satisfied. What we have to study is whether we will be funding projects that get the money moving through the system rapidly. If you give me one dollar, and I put it into my savings account, the bank may lend it out in a few weeks to someone who might use the loan to make a down payment on a house a month later. In this example, the single dollar changes hands three times in a couple of months. The economy basically had three dollars pumped into circulation over two months. If, instead, you give me one dollar, and I use it to pay for groceries, and the store uses it to replace the item I bought, and the wholesaler uses it to pay his employee, and the employee uses it to pay for gasoline, and the gas station owner uses it to buy more gasoline to sell, the same dollar changes hands six times in a few days. There are effectively six dollars pumped into circulation in a few days, or potentially, more than one hundred dollars added to the circulation in the same two month period as before. If we want a rapid recovery from our economic malaise, we need to get the new money pumped into the economy in ways that make it circulate from person to person and company to company in a high-velocity fashion. The faster the money circulates, the more quickly we will recover. The problem right now is that people have stopped buying whenever possible. In a bad economy the velocity of money circulation slows to a crawl.

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