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Money Stock and Price Level

Correlation analysis shows that there is a significant relationship between money stock (M2) and CPI (r=0.9689), which means that changes in money stock and changes in CPI are very strongly related. A relationship of similar strength exists between money stock (M2) and GDP price deflator (r=0.9696). This means that money stock and price level (as well as inflation level) are significantly related to each other (both CPI and GDP price deflator can be used as different measures of inflation).

The relationship between monetary base and GDP deflator is also strong (r=0.8472), as well as the relationship between monetary base and CPI (r=0.8385). However, the relationships of monetary base to the variables measuring price levels are of moderate strength, which means that money stock is more strongly related to price level and inflation than monetary base.

It is useful to explore the changes of money velocity over time. The velocity of money describes the rate of money circulation, and shows the propensity of the economy to inflation. Velocity was calculated in two different ways: as nominal GDP divided by money stock, and as nominal GDP divided by monetary base.

Velocity chart based on money stock shows that velocity increased during 1991-1995 period, declined in 2000 (and slightly rebounded until 2008), and significantly dropped in 2009. This decrease reflects the expansionary methods of monetary policy which were applied to mitigate the effect of recession and stimulate the economy. Since 2009, velocity (based on money stock) started gradually increasing, which means that the economy is recovering. However, the increase in velocity is rather moderate, which might mean that the economy is close to the liquidity trap.

Velocity chart calculating using monetary base confirms the above-mentioned trends. However, this chart shows that monetary base was expanding since 1989 (and velocity consequently showed a trend for decrease). The huge drop in the end of 2008 illustrates the monetary stimulation, and the decline in 2010 indicates that the monetary base is still expanding (which might confirm the closeness of the liquidity trap). At the same time, the recent increase of monetary-base focused velocity shows that there was a certain economic revival in the end of 2010 – the first half of 2011.