The Velocity of Money

The discussion on supply of money referred to the quantity of money at a particular point of time. However, Irving Fisher and other exponents of Quantity Theory of Money were more interested in the concept of the supply of money over a period of time rather than at a point of time.

Fisher uses the concept of transactions velocity to find out the money value of total transactions during a given period. Transactions velocity is defined as the average number of times a unit of money changes hands for moneys activities during a given period For example, if a hundred rupee note passes fives hands on average during a time period, it means that the hundred rupee note has served transactions worth Rs. 500. In this case, transactions velocity is equal to 5. Higher velocity of circulation implies smaller quantity of money required to meet a given money value of total transactions. Transactions velocity of money depends upon the payments practises and other structural features of the economy. Since these determinants are found to change slowly, the. transactions velocity is also considered as slow changing.

With the development of national income accounting techniques, the transactions velocity gave place to income velocity of money. Income velocity of money is defined as the average number of times a unit of money is used for making payments for final goods and services only. Obviously, income velocity of money will be smaller than transactions velocity because the latter refers to all transactions. Income velocity of money depends upon the structural factors like payments practices, the business organisation and the working of the mechanism for transferring payments in the economy. Income velocity of idle money balances (e.g. hoardings) in an economy is zero. Greater the share of idle balances in the total money stock, the smaller will be the share of the total money stock available to finance purchases of final goods and services, resulting in low-income velocity of money.

Mayank Rai

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