MV = PQ

Every week, when my copy of The Economist arrives, the first thing I do is look at the tables in the back. One of the first things that jumps out is that in Canada, no matter whether one uses M1 or M2 to measure the money supply, we have been experiencing monetary growth at a rate of about 10% per year for quite some time.

We have been experiencing real growth rates between 2 and 3 percent per year in Canada. We have also been experiencing rates of inflation around 2 percent per year.

Since the Quantity Equation for money is a tautology, that must mean that the income velocity of money has been declining at a rate of about 5% per year. Why?

One reason is the low nominal interest rates in Canada; the opportunity costs of staying liquid are not very high. Another reason is that increasingly financial institutions are arranging to make (minor) interest payments on balances, whether they are M2 or just M1 balances, so the distinction between the two is no longer very important.

I honestly do not see how the velocity can keep dropping. If I am correct, and if the Bank of Canada continues to pump up the money supply at annual rates approaching 10%, look for more inflationary pressure in the Canadian economy.