In the mid-nineteenth century, economists first began to study the relationship between money and economic activity. One of their earliest discoveries was that the velocity of money has an effect on inflation rates and production levels. While we still have much more to learn about this phenomenon, here are some interesting facts that can help you understand why it matters.

## What is the velocity of money? – Definition

But what exactly is money velocity? It’s a measure of how many times, on average, a dollar is used to purchase final goods and services within a given period of time. For example, if you buy something with your dollar bill and then someone else buys something else from the same store with that same dollar bill later in the day, your currency has been used twice in one day. In this case, the velocity of your currency was 2.

## Example

While there are several uses, one major application involves gauging the effect of monetary policy on inflation and production levels, as well as predicting trends in economic growth or recession.

For example, if a central bank increases its money supply and velocity remains constant, then more transactions will take place. This would result in higher prices. Conversely, if the central bank lowers its money supply while velocity remains unchanged, then fewer transactions would occur but each transaction would be larger since all prices (and therefore their values) remained constant.

## FAQ

What is an example of the velocity of money?

The transaction velocity is the number of times on average that a dollar is used for a transaction.

Why is the velocity of money so low?

Coronavirus economic relief efforts aided money supply growth, while fewer transactions were made throughout the economy due to consumer savings increasing from economic uncertainty, ultimately decreasing money velocity.

Does velocity of money cause inflation?

A higher velocity is a sign that the same amount of money is being used for a number of transactions. A high velocity indicates a high degree of inflation.