Few theoretical relationships in economics hold quite this well. Recall that a Keynesian liquidity trap occurs at the point when interest rates become so low that cash balances are passively held regardless of their size. The relationship between interest rates and velocity therefore goes flat at low interest rates, since increases in the money stock simply produce a proportional decline in velocity, without requiring any further decline in yields. Notice the cluster of observations where interest rates are zero? Those are the most recent data points.
One of the most fascinating aspects of the current debate about monetary policy is the belief that changes in the money stock are tightly related either to GDP growth or inflation at all. Look at the historical data, and you will find no evidence of it. Over the years, I've repeatedly emphasized that inflation is primarily a reflection of fiscal policy - specifically, growth in the outstanding quantity of government liabilities, regardless of their form, in order to finance unproductive spending. Look at the experience of the 1970's (which followed large expansions in transfer payments), as well as every historical hyperinflation, and you'll find massive increases in government spending that were distributed without regard to production (Germany's hyperinflation, for instance, was provoked by continuous wage payments to striking workers). Likewise, real economic growth is the result of hundreds of millions of individual decision-makers, each acting in their best interests to shift their consumption plans, saving, and investment in response to desirable opportunities that they face. Their behavior cannot simply be induced by changes in the money supply or in interest rates, absent those desirable opportunities.
You can see this clearly in U.S. data since 1947. Expand the quantity of base money, and it turns out that velocity falls in nearly direct proportion. The cluster of points at the bottom right reflect the most recent data.
