What Is the Neutrality of Money?
Let me explain the neutrality of money directly: it's an economic theory that states changes in the money supply only impact nominal variables, not real ones. You see, this means central banks printing more money can affect prices and wages, but it won't change the economy's output or structure.
In modern takes on this, we accept that money supply shifts might influence output or unemployment briefly. But over the long run, after the money spreads through the economy, many economists assume neutrality holds.
Understanding the Neutrality of Money
At its core, this theory views money as a neutral factor with no real effect on economic equilibrium. I want you to think about it this way: printing more money can't alter the economy's fundamentals, even if it boosts demand and raises prices for goods, services, and wages.
The idea assumes all markets clear continuously, with relative prices adjusting flexibly toward equilibrium. Changes in money supply don't create or destroy machines, introduce new trading partners, or affect knowledge and skills—so aggregate supply stays constant.
Not all economists buy into this fully, and those who do often say it applies mainly in the long term. In fact, long-run money neutrality underpins most macroeconomic theory, helping mathematical economists predict policy effects.
Consider an example: when studying the Federal Reserve's open market operations, a macroeconomist doesn't expect money supply changes to alter future capital, employment, or real wealth in long-run equilibrium. Those elements remain steady, providing stable predictive tools.
Neutrality of Money History
This concept emerged from the Cambridge tradition in economics between 1750 and 1870. Early versions claimed money levels couldn't affect output or employment, even short-term, with a vertical aggregate supply curve meaning price changes don't shift output.
Believers thought money supply shifts hit all goods and services proportionally and almost instantly. But many classical economists pointed to short-term non-neutrality from factors like price stickiness or low business confidence.
Friedrich A. Hayek coined 'neutrality of money' in 1931, originally linking it to interest rates avoiding malinvestments and business cycles in Austrian theory. Later, neoclassical and neo-Keynesian economists adapted it to their frameworks, shaping its current meaning.
Neutrality of Money vs. Superneutrality of Money
There's a stronger version called superneutrality of money. It assumes that even changes in the money supply growth rate don't affect economic output, impacting only real money balances and ignoring short-run frictions in economies used to steady money growth.
Criticism of the Neutrality of Money
This theory faces pushback from economists like John Maynard Keynes, Ludwig von Mises, and Paul Davidson, with post-Keynesian and Austrian schools rejecting it. Studies show money supply variations influence relative prices over long periods.
The main critique is that increasing money supply reduces money's value, leading to higher prices for equilibrium. This price rise affects how people and businesses engage with the economy, impacting consumption and production.
Related Concepts
Long-run money neutrality means changes in money supply have no real effects over time, though short-term impacts on employment, output, and debt occur from policies.
Non-neutrality of money is the opposite, arguing money supply changes significantly and lastingly alter the economy's structure.
Price stickiness, where nominal prices resist change despite economic shifts, is a key reason economists cite for money's non-neutrality.
The Bottom Line
In summary, the neutrality of money theory holds that money supply changes don't affect the overall economy, limiting impacts to prices and wages, not productivity or fundamentals. Some see it working long-term but not short-term, while others dismiss it entirely.
Key Takeaways
- Changes in money supply affect prices of goods, services, and wages, but not overall economic productivity.
- Money supply shifts don't alter the economy's underlying conditions, so aggregate supply remains constant.
- Some economists agree the theory applies only over the long term.
- Critics say price increases from money supply changes necessarily impact consumption and production.
Other articles for you
A quiet title action is a legal process to resolve property ownership disputes and establish clear title.
A Master of Business Administration (MBA) is a graduate degree that provides advanced training in business management, leadership, and specialized fields to enhance career prospects.
The Hodrick-Prescott filter is a macroeconomic tool that smooths data by removing short-term business cycle fluctuations to reveal long-term trends.
Position trading involves buying and holding investments long-term to capitalize on trends until they peak.
The expenditure method calculates GDP by summing up total spending on consumption, investment, government purchases, and net exports.
Extended trading enables stock transactions outside regular exchange hours through electronic networks, offering quick reactions to news but with notable risks.
Obsolete inventory refers to unsellable goods at the end of their life cycle that companies must write down or off, leading to financial losses and operational issues.
Bayes' Theorem is a formula for calculating conditional probabilities by updating prior beliefs with new evidence.
WM/Reuters benchmark rates are standard spot and forward FX rates used for portfolio valuation and performance measurement.
The OTCBB was a FINRA-operated quotation service for OTC stocks that was phased out in 2021 in favor of OTC Markets Group's platforms.