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Income velocity of circulation



The rate at which MONEY circulates through the economy in order to finance transactions. It is measured where M is the money supply available in the economy for a specified period (generally a year), Y is the money value of national income over that period, and vis the income velocity of circulation. In general, v is greater than I, indicating that the quantity of money circulates more than once through the economy to finance the total volume of transactions. At one time v was regarded as an 'institutional constant' determined by factors such as the intervals at which wages and salaries are paid (weekly, monthly, etc.), the extent to which payments and receipts of income earners, firms, etc., are synchronized, and so on. As such it played an important role in both classical and Keynesian theories of the demand for money. However more recently it has been sug­gested that v may in fact be influenced by the rate of interest. When interest rates are high, people will try to economize on the cash balances they hold (since the interest rate is the opportunity cosT of holding money) and hence a given volume of transactions can be financed with a smaller stock of money, i.e. v increases. The converse applies when interest rates are low.