Familiarity with velocity of money is essential for understanding the complexities of foreign exchange (forex). As the driving force behind fluctuations in a nation’s currency rate, the velocity of money formula is often used to calculate the money supply and borrowing power of a country. This article will explain what velocity of money is, how it relates to forex, and the different ways it is used in currency analysis. The velocity of money formula is used to measure the average frequency at which a unit of money is used to purchase goods or services within a given period. Specifically, the formula states that the velocity of money (V) is equal to the total amount of money spent (P) divided by the total amount of money in circulation (M):
V = P/M
In a series of simple terms, the velocity of money indicates how often a single unit of money is exchanged within an economy. The higher the money velocity, the more frequently a unit of money is exchanged, which suggests a higher level of economic activity. In contrast, a lower money velocity suggests slower activity and a less dynamic economy.