Question

What is the velocity of money and why is its predictability important for monetary policy?

Answer 1

Velocity of money: It is the rate at which people spend cash in an economy. The rate at which money is exchanged in an economy is termed as velocity of money. It can also be termed as turnover in the money supply as it is the amount of money that is circulated in the economy during a given period of time.

It is a very important factor for the monetary policy. It is basically how the velocity of money changes that determines whether the goals of monetary policy are achieved or not. For example, during the period of inflation, the central banks use contractionary monetary policy, which reduces the supply of money in the market, eventually the velocity of money decrease as it is the frequency of monetary transactions in the country whoch tend to reduce during the contractionary policy. This is how monetary policy and velocity of money are linked.

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