Where Is the Economy Heading? Velocity of Money Provides Clues

I often get asked my thoughts on where the economy is heading, and sadly, I don’t have a crystal ball, but I do have several gauges that I use to help determine the direction that the economy might be heading in. One of those gauges is the velocity of money.

Velocity of money is the rate at which money is being spent in the economy. It is calculated by dividing GDP (gross domestic product) (opens in new tab) by the money supply (M1 & M2). Both M1 and M2 can be used for calculation purposes. Think of M1 as the more focused number. This includes cash and transaction deposits, whereas M2 is larger and encompasses savings, CDs and money markets. GDP is the value of all goods and services in the economy.

The faster money changes hands within the economy, the stronger the economy is thought to be. Therefore, if we see a trend in either direction, we can assume that the economy is getting better or worse depending on the direction of the velocity of money, either up or down.

Subscribe to Kiplinger’s Personal Finance

Be a smarter, better informed investor.

Save up to 74%

Sign up for Kiplinger’s Free E-Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

Sign up

Sometimes the velocity of money can be affected simply by things like rising inflation. During periods of higher inflation, the velocity of money tends to increase. This is why I have been monitoring it more closely this year.

As you know, the Fed has been desperately trying to reduce inflation by raising interest rates in an attempt to slow the economy. One of the ways we check on if its attempts are working is to see if the velocity of money is declining. If not, signs might point to continued elevated inflation.

It's important to note that the velocity of money isn’t the end-all for measuring the economy. The Fed’s manipulation of its balance sheet changes GDP and therefore the velocity-of-money calculation, which some argue makes the velocity-of-money figure less valuable.

I would argue a higher velocity-of-money figure does represent a decent picture of higher inflation, but it is somewhat less reliable when it’s falling. This is why other factors need to be considered in order to make an assumption about the direction of the economy.

So, what are my thoughts? I think we will see a recession in 2023, but that it likely won’t be either deep or prolonged. I think the market has already priced this in, and therefore, a recession won’t have much of a negative effect, if any, on the stock market.

This is purely my opinion.

As a result, I am buying more stocks now than I have all year and will likely continue to do so.

Remember, everyone’s situation is different, and what you should do could be completely different than what someone else does.

My suggestion is to review your plan with your adviser, and if you don’t have a plan, then you need a financial planning professional to make one for you.

These times are too turbulent to “wing it.”

Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. Reich Asset Management, LLC is not affiliated with Kestra IS or Kestra AS. The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax adviser with regard to your individual situation. To view form CRS visit https://bit.ly/KF-Disclosures (opens in new tab).