From the St. Louis Fed:
The velocity of money is the frequency at which one unit of currency is used to purchase domestically- produced goods and services within a given time period. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. If the velocity of money is increasing, then more transactions are occurring between individuals in an economy.
The frequency of currency exchange can be used to determine the velocity of a given component of the money supply, providing some insight into whether consumers and businesses are saving or spending their money. There are several components of the money supply,: M1, M2, and MZM (M3 is no longer tracked by the Federal Reserve); these components are arranged on a spectrum of narrowest to broadest. Consider M1, the narrowest component. M1 is the money supply of currency in circulation (notes and coins, traveler’s checks [non-bank issuers], demand deposits, and checkable deposits). A decreasing velocity of M1 might indicate fewer short- term consumption transactions are taking place. We can think of shorter- term transactions as consumption we might make on an everyday basis.
The broader M2 component includes M1 in addition to saving deposits, certificates of deposit (less than $100,000), and money market deposits for individuals. Comparing the velocities of M1 and M2 provides some insight into how quickly the economy is spending and how quickly it is saving.
MZM (money with zero maturity) is the broadest component and consists of the supply of financial assets redeemable at par on demand: notes and coins in circulation, traveler’s checks (non-bank issuers), demand deposits, other checkable deposits, savings deposits, and all money market funds. The velocity of MZM helps determine how often financial assets are switching hands within the economy.”
In short, money is not being spent that often. All of those helicopter airdrops of cash by the Federal Reserve? They’re not going into the real economy and are not being spent on stuff by real people (who increasingly don’t have any money). If they were, the above three graphs would bear some semblance to that of the money supply below:
This is where our friend Mr. Income Inequality comes in. Taking the social justice argument out of the picture (let’s say it got sent to a labor camp, it’d be fitting), a huge concentration of money at the top will inevitably slow down the money supply because even the most frivolous-spending rich person will only spend so much per year, with the rest going into savings/investments/etc (why do you think the stock market keeps hitting record highs?). That money is not creating jobs, growing businesses, or even being spent on dumb shit. All it’s doing is making some guy with an insane amount of money even more money – something the Fed and our government are effectively encouraging with their current policies.
Until that money is brought into the real economy through some means like increased capital expenditures, taxation and public spending, direct payments to taxpayers – pick a method that jives with your ideology – the velocity of money and the real economy will continue to kind of suck. You simply can’t have a consumer spending-based economy if most consumers are broke and jobless. Good thing the unemployment rate went down! Oh wait…