Neutrality of money

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Neutrality of money is the idea that a change in the

real business cycle models). Others like monetarism
view money as being neutral only in the long run.

When neutrality of money coincides with zero population growth, the economy is said to rest in steady-state equilibrium.[2]: 41–43 

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.[3]

History of the concept

According to

Keynes rejected neutrality of money both in the short term and in the long term.[6]

Views and counterviews

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

psychological threshold due to money illusion
.

Neutrality of money has been a central question for

monetary authority
chooses to increase the stock of money and, hence, the price level, agents will be never able to distinguish real and nominal changes, so they will regard the increase in nominal wages as real modifications, so labour supply will also be boosted. However, this change is only temporary, since agents will soon realize the actual state of affairs. As the higher wages were accompanied by higher prices, no real changes in income occurred, that is, it was no need to increase the labour supply. In the end, the economy, after this short detour, will return to the starting point, or in other words, to the natural rate of unemployment.

Robert E. Lucas, also has its own Phillips curve. However, things are far more complicated in these models, since rational expectations were presumed. For Lucas, the islands model made up the general framework in which the mechanisms underlying the Phillips curve could be scrutinized. The purpose of the first Lucasian island model (1972) was to establish a framework to support the understanding of the nature of the relationship between inflation and real economic performance by assuming that this relation offers no trade-off exploitable by economic policy. Lucas' intention was to prove that the Phillips curve exists without existing. It has been a heritage that there is a trade-off between inflation and unemployment or real economic performance, so it is undoubted that there is a short run Phillips curve (or there are short run Phillips curves). Although there are fewer possible actions available for the monetary policy to conceit people in order to increase the labour supply, unexpected changes can always trigger real changes. But what is the ultimate purpose of the central bank when changing the money supply? For example, and mostly: exerting countercyclical control. Doing so, monetary policy would increase the money supply in order to eliminate the negative effects of an unfavourable macroeconomic shock. However, monetary policy is not able to utilize the trade-off between inflation and real economic performance, because there is no information available in advance about the shocks to eliminate. Under these conditions, the central bank is unable to plan a course of action, that is, a countercyclical monetary policy. Rational agents can be conceited only by unexpected changes, so a well-known economic policy is completely in vain. However, and this is the point, the central bank cannot outline unforeseeable interventions in advance, because it has no informational advantage over the agents. The central bank has no information about what to eliminiate through countercyclical actions. The trade-off between inflation and unemployment exists, but it cannot be utilized by the monetary policy for countercyclical purposes.[7]

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.

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 the supply of 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.[8][9][10][11][12]

See also

Notes

  1. ^ Patinkin, Don (1987), Neutrality of Money, Palgrave
  2. ISBN 9780262013772
    .
  3. ^ Stefan Homburg (2015). Superneutrality of Money under Open Market Operations, IDEAS. Retrieved 18 January 2015.
  4. ^ See David Laidler (1992). "Hayek on Neutral Money and the Cycle," UWO Department of Economics Working Papers #9206. and Roger Garrison & Israel Kirzner. (1987). "Friedrich August von Hayek," John Eatwell, Murray Milgate, and Peter Newman, eds. The New Palgrave: A Dictionary of Economics London: Macmillan Press Ltd., 1987, pp. 609–614
  5. ^ See the Google NGRAM for 'neutral money'
  6. ^ The Collected Writings, vol 13, pp. 408–411
  7. ISBN 978-3-319-17578-2
    .
  8. doi:10.1111/j.1540-6261.1977.tb03305.x
    .
  9. ^ Fried, Joel; Howitt, Peter. "The effects of inflation on real interest rates". 73 (December 1983). American Economic Review: 968–980. {{cite journal}}: Cite journal requires |journal= (help)
  10. doi:10.1111/j.1540-6261.1979.tb02069.x
    .
  11. S2CID 153733633
    .
  12. doi:10.1111/j.1540-6261.1985.tb04977.x
    .

References

  • New Palgrave: A Dictionary of Economics, v. 3, pp. 639–44. Reprinted in John Eatwell et al. (1989), Money: The New Palgrave, p p. 273-- [1]
    287.
  • Friedrich Hayek (1931) Prices and Production. London: G. Routledge & Sons.
  • Friedrich Hayek (1933 in German). "On 'Neutral Money'," in F. A. Hayek. Money, Capital, and Fluctuations: Early Essays, edited by Roy McCloughry, Chicago, University of Chicago Press, 1984.
  • David Laidler (1992). "Hayek on Neutral Money and the Cycle," UWO Department of Economics Working Papers #9206.
  • Roger Garrison & Israel Kirzner. (1987). "Friedrich August von Hayek," John Eatwell, Murray Milgate, and Peter Newman, eds. The New Palgrave: A Dictionary of Economics London: Macmillan Press Ltd., 1987, pp. 609–614
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