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Neutrality of money

Neutrality of money is the idea that a change in the stock of money affects only nominal variables in the economy such as prices, wages and exchange rates, with no effect on real (inflation-adjusted) variables, like employment, real GDP, and real consumption.[1]

Neutrality of money is an important idea in classical economics and is related to the classical dichotomy. It implies that the central bank does not affect the real economy (e.g., the number of jobs, the size of real GDP, the amount of real investment) by printing money. Instead, any increase in the supply of money would be offset by a proportional rise in prices and wages. This assumption underlies some mainstream macroeconomic models (e.g., real business cycle models) while others like monetarism view money as being neutral in the long-run.

Superneutrality of money is a stronger property than neutrality of money. It holds that not only is the real economy unaffected by the level of the money supply but also that the rate of money supply growth has no effect on real variables. In this case, nominal wages and prices remain proportional to the nominal money supply not only in response to one-time permanent changes in the nominal money supply but also in response to permanent changes in the growth rate of the nominal money supply. Typically superneutrality is addressed in the context of long-run models.


History of the concept

According to Don Patinkin, the concept of monetary neutrality goes back as far as David Hume. The term itself was first used in the 1920s and 1930s by a variety of continental economists (but was mistakenly attributed by Friedrich von Hayek to Knut Wicksell).[1] Keynes rejected neutrality of money both in the short term and in the long term.[2]


Many economists maintain that money neutrality is a good approximation for how the economy behaves over long periods of time but that in the short run monetary-disequilibrium theory applies, such that the nominal money supply would affect output. One argument is that prices and especially wages are sticky (because of menu costs, etc.), and cannot be adjusted immediately to an unexpected change in the money supply. An alternative explanation for real economic effects of money supply changes is not that people cannot change prices but that they do not realize that it is in their interest to do so. The bounded rationality approach suggests that small contractions in the money supply are not taken into account when individuals sell their houses or look for work, and that they will therefore spend longer searching for a completed contract than without the monetary contraction. Furthermore, the floor on nominal wages changes imposed by most companies is observed to be zero: an arbitrary number by the theory of monetary neutrality but a psychological threshold due to money illusion.

The New Keynesian research program in particular emphasizes models in which money is not neutral in the short run, and therefore monetary policy can affect the real economy.

Post-Keynesian economics and monetary circuit theory reject the neutrality of money, instead emphasizing the role that bank lending and credit play in the creation of bank money. Post-Keynesians also emphasize the role that nominal debt plays: since the nominal amount of debt is not in general linked to inflation, inflation erodes the real value of nominal debt, and deflation increases it, causing real economic effects, as in debt-deflation.

Reasons for departure from superneutrality

Even if money is neutral, so that the level of the money supply at any time has no influence on real magnitudes, money could still be non-superneutral: the growth rate of the money supply could affect real variables. A rise in the monetary growth rate, and the resulting rise in the inflation rate, lead to a decline in the real return on narrowly defined (zero-nominal-interest-bearing) money. Therefore people choose to re-allocate their asset holdings away from money (that is, there is a decrease in real money demand) and into real assets such as goods inventories or even productive assets. The shift in money demand can affect nominal interest rates on loanable funds, and the combined changes in the nominal interest rate and the inflation rate may leave real interest rates changed from previously. If so, real expenditure on physical capital and durable consumer goods can be affected.[3][4][5][6][7]


U.S. National Bureau of Economic Research member and International Monetary Fund chief economist Olivier Blanchard has said, there is no real evidence: "All the models we have seen impose the neutrality of money as a maintained assumption. This is very much a matter of faith, based on theoretical considerations rather than on empirical evidence."[8] Recognition of the short-run non-neutrality of money led to the development of the New Keynesian class of macroeconomic models.

Empirical studies have shown that money is neutral in the long-run.[9] Nonetheless, it is also true that the way in which money is supplied today, i.e. through debt, is actually affecting the economy and pushing for growth, both in the short and in the long run (see Critics to fractional reserve banking). It can therefore be argued that while sound money is neutral over the long term, fiat money is not.

See also



de:Neutralit t des Geldes it:Neutralit della moneta nl:Neutraliteit van geld no:Pengen ytralitet pl:Zasada neutralno ci pieni dza

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