The more an item is being cycled through our economy (a faster velocity of money), the more GDP it produces, even if the same item remains no change. However, in macroeonomy, we believe that money velocity equates GDP.
For example, an item worth $100 purchased by A is now being purchased by B for $100. GDP totals $200 but the item is only valued at $100. Therefore, the formula to sum this up is MV = PY where M is the money supply, V is the velocity of money, P is the price level or inflation, and Y is the real GDP.
if the fed “prints” a lot of money but the velocity of money actually decreases, then PV stays the same.
Let’s imagine manufacturers of common goods all over the nation are having trouble selling their products. The fed would then prints money to buy treasury bonds of the government, then the government would buy the manufacturing goods using the money printed. Now that the manufacturers has the money, they obviously would make the choice of using the money for payments of any of the amount due. They would also lower the production speed and save the left-over money in the bank for emergency use. Even though the bank receives extra money, at time of bad economy, banks are not willing to committe acts with high risks by loaning out their money. So the bank will save the money from the manufactuers.
Even though the fed prints money and cycles the money to the hands of those who need money, inflation has not incurred due to the a lower velocity of money. Now the fed also has the option of lower the interest rate to disencourage everyone from putting their money in the bank. However, the manufactuers would most likely buy gold or other financial assets to hedge against the low interest environment.
Therefore, printing money does not automatically equates to inflation. It does, however, reflects to the fed’s willingness to faciliate intention of inflation. The real measurement of inflation is by analyzing CPI data. The fed would then adjust money supplies and interest rate to balance CPI data.
Lastly, inflation is also tied to the foreign exchange which I have ignored in this passage.
Benc Tan 