The neutrality of money is an economic theory that posits that changes in the aggregate money supply only affect nominal variables (such as prices and wages) and have no long-term impact on real variables (like output, employment, and real interest rates). This theory suggests that in the long run, monetary policy does not influence the real economy.
Historical Context
Origins and Development
The concept of money’s neutrality can be traced back to classical economics, especially the work of David Hume in the 18th century. Hume’s “Essay on Money” introduced the notion that changes in the money supply affect prices but do not alter the real output or employment in the long term.
Classical and Neoclassical Perspectives
In classical and neoclassical economics, the neutrality of money is a fundamental assumption. Economists like John Stuart Mill and Milton Friedman have argued that, over the long run, adjustments in the money supply are reflected in proportional changes in the price level without affecting real economic variables.
Critique and Counterarguments
Keynesian View
Keynesian economists challenge the neutrality of money by emphasizing the short-run non-neutrality of money. According to Keynesians, changes in the money supply can impact real variables like output and employment in the short run due to price and wage rigidities.
Real Business Cycle Theory
Real Business Cycle (RBC) theorists, who emphasize technological shocks, also question the strict neutrality of money, suggesting that monetary policy can have real effects under certain conditions.
Applicability in Modern Economics
Monetary Policy Implications
While the neutrality of money holds significance in long-run analysis, modern central banks recognize that in the short run, changes in the money supply can influence economic activity. This has led to policies that aim to mitigate short-term economic fluctuations through monetary interventions.
Empirical Evidence
Empirical studies have demonstrated mixed results regarding the neutrality of money. Some evidence supports the idea that money is neutral in the long run, while other studies show significant short-term impacts on real variables due to monetary changes.
Related Terms
- Real vs. Nominal Variables: - Real Variables: Measures adjusted for changes in price level (e.g., real GDP, real interest rates).
- Nominal Variables: Measures not adjusted for changes in price level (e.g., nominal GDP, nominal wages).
- Monetary Neutrality vs. Superneutrality: - Monetary Neutrality: Changes in the money supply affect only nominal variables in the long run.
- Monetary Superneutrality: Changes in the rate of growth of the money supply do not affect real variables.
FAQs
Is the neutrality of money universally accepted in economics?
Does monetary neutrality imply no role for monetary policy?
Can changes in the money supply affect unemployment?
References
- Hume, David. “Essays, Moral, Political, and Literary.” 1758.
- Mill, John Stuart. “Principles of Political Economy.” 1848.
- Friedman, Milton. “The Role of Monetary Policy.” American Economic Review, 1968.
- Baxter, Marianne, and Robert G. King. “Measuring Business Cycles: Approximate Band-Pass Filters for Economic Time Series.” Review of Economics and Statistics, 1999.
Summary
The neutrality of money theory remains a pivotal concept in economic thought, primarily asserting that changes in the money supply only impact nominal variables. While foundational for classical and neoclassical economics, it faces robust critiques from various economic schools, providing a rich terrain for ongoing debate and empirical investigation. Understanding its implications and limitations is crucial for formulating effective economic and monetary policies.
