What is the Velocity of Money?

By Gary Tedrow, Western Ohio Mortgage

If you’ve been watching the economic news, you’ve probably
noticed that market experts and traders have been keeping a close eye on the
Commerce Department’s Personal Spending and Personal Income reports. Obviously,
those reports provide insight into the health of our economy, but did you know
they also influence home loan rates? That’s right, personal spending can actually
influence the interest rates that are available when you purchase or refinance
a home.

Here's why. It has to do with something called the velocity of money.

Even though the government keeps
pumping money into the system, nothing happens until that money is spent or
lent – and passes from one hand to another or one business to another. The
speed at which this money passes between parties is called the velocity of
money.

With the job market still very sluggish, consumers aren't spending much money
these days, and businesses are still reluctant to spend money to make
investments in their business. With the present velocity at low levels,
inflation remains subdued and that's good for home loan rates. That's because
rates are tied to Mortgage Bonds and inflation is the archenemy of Bonds, so
low inflation is good for Bonds and rates. However, once velocity increases,
the excess money in the system will cause inflation – which is bad for rates,
since even the slightest scent of inflation can cause home loan rates to
worsen.

While we certainly want to see better economic recovery news in the near
future, we have to remember that there's an inverse relationship between good
economic news and Bonds and home loan rates. Weak economic news normally causes
money to flow out of Stocks and into Bonds, which helps Bonds and home loan
rates improve. Strong economic news, on the other hand, normally has the
opposite result.

Currently, home loan rates are at
a historically low level, but that situation won’t last forever. That means now
is an ideal time to purchase a home or refinance before the velocity of money –
and rates – change. .

­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­Gary Tedrow is affiliated with Western Ohio Mortgage
Corp], NMLS 179207