Factors influencing Velocity of Circulation of Money

Velocity of Circulation refers to the average number of times a single unit of money changes hands in an economy during a given period of time. It can also be referred to as the velocity of money or velocity of circulation of money. It is the frequency with which the total money supply in the economy turns over in a given period of time.

If the velocity of money is increasing, then the velocity of circulation is an indicator that transactions between individuals are occurring more frequently. 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.

Factors Affecting the Velocity of Circulation

• Money Supply:

Money supply and the velocity of money are inversely proportional. If the money supply in an economy falls short, then the velocity of money will rise, and vice versa.

Velocity of money depends upon the supply of money in the economy. If the supply of money in the economy is less than its requirements, then the velocity of money will increase and if the money supply is less than its requirement, the velocity of money will fall.

• Frequency of Transactions:

As the number of transactions increases, so does the velocity of circulation.

With the increase in the frequency of transactions, the number of payments and receipts increases and, as a result, velocity of money increases. Similarly, with the decrease in the frequency of transactions, the velocity of money decreases.

• Regularity of Income: Regularity of income enables people to spend their money more freely, leading to a rise in the velocity of circulation.
• Payment System: It is also affected by the frequency with which labor is paid (weekly, monthly, bi-monthly) and how fast the bills for various goods and services are settled. The velocity of money is also determined by the frequency with which the labour force is paid (i.e., weekly or monthly) and the speed with which the bills for goods are settled.
• Regularity of Income: If people receive income at regular intervals, they will spend their income more freely and the velocity of money will increase. But, if people receive their income at irregular intervals, they will prefer to hold more cash balances to meet the uncertain conditions in future and the velocity of money will fall.
• Propensity to Consume: Greater the tendency of the people to consume, other things remaining the same, higher will be the velocity of money. On the contrary, lower the propensity to consume, lesser will t3 the velocity of money. Saving, or not consuming, has an adverse effect on the velocity of money.

There are several other factors involved, including the value of money, the volume of trade, credit facilities available in the economy, business conditions, etc.

Monetarism and Keynesian Economics

There is a conflict of belief between Monetarists and Keynesian economists regarding the concept. Monetarists believe in the stability of the velocity of circulation and argue that there is a direct relationship between money supply and price levels, and between the rate of growth of money supply and rate of inflation. On the other hand, Keynesian economists believe that the velocity of circulation is an unstable concept that can change rapidly, leading to changes in the money supply.

Formula:

The GDP equation is as follows:

Gross Domestic Product (GDP) = Money Supply x Velocity of Circulation

Therefore, the formula for velocity is the following:

Velocity of Circulation = Gross Domestic Product (GDP) / Money Supply