What Is the Neutrality of Money?

The neutrality of money, also called neutral money, is an economic theory stating that changes in the money supply only affect nominal variables and not real variables. In other words, the theory says that the amount of money printed by 澳洲幸运5开奖号码历史查询:central banks can impact prices and wag🥃es, 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 澳洲幸运5开奖号码历史查询:economists believe that neutrality iಞs assꦆumed in the long-run after money circulates throughout the economy.

Understanding the Neutrality of Money

The neutrality of money theory is based on the idea that money is a “neutral” factor that has no real effect on 澳洲幸运5开奖号码历史查询:economic equilibrium. Printing more money cannot change the fundamental nature of the economy, even if it drives up demand and leads to anꦐ increase in the prices of goods, services, and wages.

According to the theory, all markets for all goods clear continuously. Relative prices adjust flexibly and always toward equilibrium. Changes in the supply of money do not appear to change the underlying conditions in the economy. New money neither creates nor destroys machines, it does not introduce new trading partners, it does not affect existing knowledge and skill. As a result, 澳洲幸运5开奖号码历史查询:aggregate supply should remain constant.

Not every economist agrees with this way of thinking and those who do generally believe that the neutrality of money theory is only truly applicable over the long term. In fact, the assumption of long-run money neutrality underlies almost all 澳洲幸运5开奖号码历史查询:macroeconomic theory. Mathematical economists rely on this classical di🍌chotomy to predict 💦the effects of economic policy.

An example of the neutrality of money can be seen if a macroeconomist is studying the 澳洲幸运5开奖号码历史查询:monetary policy of a central bank, such as the 澳洲幸运5开奖号码历史查询:Federal Reserve (Fed). When the Fed engages in 澳洲幸运5开奖号码历史查询:open market operations, the macroeconomist does not assume that changes in the money supply will change future capital equipment, employment levels, or real wealth in long-run equilib𝓀rium. Those factors will remain consta🥂nt. This gives the economist a much more stable set of predictive parameters.

Neutrality of Money History

Conceptually, money neutrality grew out of the Cambridge tradition in economics between 1750 and 1870. The earliest version posited that the level of money could not affect output or employment even in the short run. Because the aggregate 澳洲幸运5开奖号码历史查询:supply curve is presumed to be vertical, a change in the 澳洲幸运5开奖号码历史查询:price level does not alter the aggregate output.

Adherents believed shifts in the money supply affect all goods and services proportionately and nearly simultaneously. However, many of the 澳洲幸运5开奖号码历史查询:classical economists rejected this notion and believed 澳洲幸运5开奖号码历史查询:short-term factors, such as 澳洲幸运5开奖号码历史查询:price stickiness or depressed business confi𝓡dence, were sources of non-neutrality.🐽

The phrase “neutrality of money” was coined by Austrian economist Friedrich A. Hayek in 1931. Originally, Hayek defined it as a market rate of interest at which malinvestments—poorly allocated business investments according to Austrian business cycle theory—did not occur and did not produce business cycles. Later, 澳洲幸运5开奖号码历史查询:neoclassical and 澳洲幸运5开奖号码历史查询:neo-Keynesian economists adopted the phrase and a🍎pplied it to their gene♛ral equilibrium framework, giving it its current meaning.

Neutrality of Money vs. S🥃uperneutrality of Money

There is an even stronger version of the neutrality of money postulate: the superneutrality of money. Superneutrality further assumes that changes in the rate of money supply growth do not affect economic output. Money growth has no impact on real variables except for real money balances. This theory disregards short-run frictions and is pertinent to an economy accustomed t𒐪o a constant money growth rate.

Criticism of the Neutrality of Money

The neutrality of money theory has attracted criticism from some quarters. Many notable economists rejected the concept in both the short- and long-run, including 澳洲幸运5开奖号码历史查询:John Maynard Keynes, 澳洲幸运5开奖号码历史查询:Ludwig von Mises, and Paul Davidson. The post-Keynesian school and 澳洲幸运5开奖号码历史查询:Austrian school of economics also dismiss it. Several 澳洲幸运5开奖号码历史查询:econometric studies suggest that variations in the money supply affect relative prices over long periods of tim🔯e.

The primary argument states that as the money supply increases, the value of money decreases. Eventually, as the increased supply of money spreads thr𒁏oughout the economy, the prices of goods and services will increase in order to reach a point of equilibri𓂃um by counteracting the increase of the money supply.

Critics also argue that an in🌜crease in the supply of money impacts consumption and production. Because an increase in the supply of money increases prices, this increase in price alters how individuals and businesses interact with the economy.

The Bottom Line

The money neutrality theory posits that changes in money supply do not affect the overall economy. Rather, the impact of such changes is limited to the realm of prices for goods and services and wages for labor—not pro♊ductivity or the fundamental nature of the economy. Some economists agree that neutrality plays out over the long-run but not on shorter timescales, while others reject the theory﷽ altogether.