That Doesn’t Sound Good

By Kleinheider Posted on November 3, 2009 at 10:34 am

Similarities abound between our “Great Recession” and the Great Depression:

“Unfortunately, the current crisis is caused by the same deflationary forces that caused the Great Depression. Monetarists dismiss this argument on the grounds that the money supply has not only not fallen, but in fact has risen sharply. At the end of September, the money supply (M2) was up by $523 billion over a year earlier–a substantial increase. For this reason, they dismiss the idea that government stimulus was necessary to get the economy moving again.

What my monetarist friends forget is that that the money supply impacts GDP through the velocity multiplier. Normally, it is around 1.9. But it fell to 1.86 in the third quarter of 2008, 1.76 in the fourth quarter, 1.7 in the first quarter of 2009 and 1.69 in the second quarter before rising a bit to 1.72 in the third quarter.

This may not sound like much, but a decline of 10% in the velocity ratio has exactly the same macroeconomic effect as a 10% decline in the money supply. If velocity were still at 1.9, third-quarter GDP would have been $15.8 trillion instead of $14.3 trillion. In other words, there would be no recession.

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