Background
The concept of the neutrality of money postulates that changes in the money supply affect only nominal variables—such as the price level—without exerting any influence on real variables—such as output or real interest rates. This essentially means that an increase in the supply of money leads to proportional increases in prices, hence affecting the economy in nominal but not real terms.
Historical Context
The idea was initially put forward by David Hume (1711–1776) in the 18th century and later incorporated into the *quantity theory of money. Hume predicted that, in the long run, the prices of goods and services grow in proportion to the money supply, without affecting real economic variables.
Definitions and Concepts
Neutrality of money encompasses several facets:
- Nominal Variables: Economic variables that are measured in monetary units, such as the price level and wage rates.
- Real Variables: Economic variables measured independently of monetary units, such as real GDP, real consumption, and real wages.
- Dynamic General Equilibrium Theory: A framework used to derive neutrality theorems, suggesting that money supply changes do not influence real output in a balanced economy.
- Non-neutrality of Money: The idea that in the short run, money supply changes can affect real economic variables like employment and output.
Major Analytical Frameworks
Classical Economics
Classical economists, following Hume’s insights, view money as neutral in the long run but acknowledge possible short-run non-neutral effects.
Neoclassical Economics
Similar to classical economists, neoclassicals maintain the long-run neutrality of money but apply mathematical models and empirical analysis for detailed understanding.
Keynesian Economic
Keynesianism diverges by asserting that in the short run, money supply increases can stimulate real economic activity—such as employment and production—particularly during economic downturns.
Marxian Economics
While economics under Marx’s analysis doesn’t focus heavily on monetary neutrality, it acknowledges the role money plays in capitalist structures but revolves more around the labor theory of value.
Institutional Economics
This framework examines the impacts of institutions, including money, on economic behaviors, focusing more on regulatory and systemic factors than simply monetary amounts.
Behavioral Economics
Behavioral economists would study how actual market behaviors might deviate from neutrality due to psychological and social effects of changing money supply.
Post-Keynesian Economics
Post-Keynesians often emphasize monetary theory’s non-neutrality, focusing on credit and finance systems’ role in shaping economic activity beyond simple money supply changes.
Austrian Economics
Austrian school views often align with the monetarist perspective, preserving long-run neutrality while emphasizing the distorting effects of inflation and non-neutral short-run implications.
Development Economics
Neutrality of money has less direct emphasis in development economics, which often focuses on structural factors influencing economic growth more than monetary aggregates alone.
Monetarism
Monetarists, following Milton Friedman, strongly advocate for long-run neutrality of money but distinguish sharply between anticipated and unanticipated monetary changes.
Comparative Analysis
Neutrality’s role varies across economic theories but prominently features in the discourse to argue the relevancy and complexity of monetary policy and its real versus nominal effects.
Case Studies
Historical evaluations across countries and varying periods demonstrate differing impacts—supporting both neutral and non-neutral outcomes under specific frameworks:
- Humean predictions regarding proportional long-run price adaption.
- Keynesian emphasis following the 1930s Depression experience.
- Empirical findings from the 1970s focusing on anticipated vs. unanticipated effects.
Suggested Books for Further Studies
- “A Treatise on Money” by John Maynard Keynes
- “The Theory of Money and Credit” by Ludwig von Mises
- “Friedman and Schwartz’s A Monetary History of the United States” by Milton Friedman and Anna Schwartz
Related Terms with Definitions
- Quantity Theory of Money: States the general price level of goods and services is directly proportional to the amount of money in circulation.
- Rational Expectations: An economic idea that agents optimally use all available information to form expectations about economic variables.
- Inflation Tax: The cost levied on holders of cash and cash-equivalents due to inflation reducing the value of their holdings.
- General Equilibrium Theory: A macroeconomic model where supply and demand are in balance within the whole economy.
