The velocity of money is the average frequency with which a unit of money is spent in a specific period of time. Velocity associates the amount of economic activity associated with a given money supply. When the period is understood, the velocity may be present as a pure number; otherwise it should be given as a pure number over time. In the equation of exchange, velocity of money is one of the key variables determining inflation.
The velocity of money measures how quickly each given dollar filters its way through the system. Right now, everyone is scared. As such, any dollars they get they put away rather than spend. As such, the velocity of money is very low. That said, there is plenty of money in the system but that money continues to be on the sidelines and not being spent as quickly. This will continue as long as the economy is weak and people are afraid. So, what will happen when we begin to recover and people feel better about the economy?
Dick Morris described it well.
Think of a parking garage filled with cars. The cars’ owners leave them in the garage, because it’s a bad day with rain and snow and conditions aren’t suitable for driving. Similarly, banks and consumers leave their money in the vault at the Fed or in their bank accounts or under the mattress.
When conditions improve, though, all those metaphorical cars will suddenly be taken out for a drive. All at once. And a traffic jam of monumental proportion will ensue.
When everybody starts spending the money they’re now leaving in vaults and mattresses, way too much money will be chasing way too few goods and services. Double-digit inflation will return to America.
You could even think of it as this analogy. Think about what happens when someone performs a neutral drop. They set the gear to neutral and hit the gas, and hit it very, very, very, hard. That's what both fed action and government stimulus have done. We can't see the effects yet because we are still in neutral, with velocity of money being very low. So, what will happen when we finally shift to drive? Well of course, the car would not only take off but take off out of control. That's what will happen as soon as the economy recovers and people start spending. Once the velocity of money becomes relatively normal or even aggressive, the full inflationary effects will be seen. They will be staggering and at that time we will begin to fully appreciate the full inflationary effects of all this monetary and fiscal stimulus.