What is Neutrality Of Money?
1464 reads · Last updated: December 5, 2024
The neutrality of money, also called neutral money, is an economic theorystating that changes in the money supply only affect nominal variables and not real variables. In other words, the amount of money printed by the Federal Reserve (Fed) and central banks can impact prices and wages but not the output or structure of the economy.Modern versions of the theory accept that changes in the money supply might affect output or unemployment levels in the short run; however, many of today’s economists still believe that neutrality is assumed in the long run after money circulates throughout the economy.
Definition
Monetary neutrality, also known as neutral money, is an economic theory that suggests changes in the money supply only affect nominal variables and not real variables. In other words, the amount of money printed by the Federal Reserve and central banks can influence prices and wages but not the output or structure of the economy.
Origin
The concept of monetary neutrality dates back to classical economics, particularly the works of David Ricardo and John Stuart Mill. The rise of Keynesian economics in the early 20th century challenged this theory, but it regained prominence in the 1970s with the revival of monetarism.
Categories and Features
Monetary neutrality can be divided into short-term and long-term categories. Short-term monetary neutrality acknowledges that changes in the money supply can affect output or unemployment levels, while long-term monetary neutrality posits that these effects will eventually dissipate, and the economy will return to its natural state. Short-term neutrality is often associated with the Phillips curve, whereas long-term neutrality relates to the natural rate of unemployment theory.
Case Studies
A typical case is the United States in the 1970s when the Federal Reserve attempted to reduce unemployment by increasing the money supply. In the short term, this policy did lower unemployment but also led to high inflation. Eventually, the economy returned to its natural unemployment rate, validating long-term monetary neutrality. Another case is Japan during its economic stagnation in the 1990s, where despite loose monetary policy, economic growth remained sluggish, supporting the idea of monetary neutrality.
Common Issues
Investors often misunderstand monetary neutrality, believing that monetary policy can change the economic structure in the long term. In reality, the impact of monetary policy is primarily short-term, with fundamental economic factors like technological progress and population growth being the long-term determinants. Moreover, monetary neutrality does not imply that monetary policy is useless but highlights its limitations in the long run.
