What is the Neutrality Of Money?

The neutrality of money is a theory that maintains that changes in the supply of money in an economy only affect nominal variables and not real variables. This means that when the Cbetra bank decides to change the supply of money, nominal variables such as prices, wages, and exchange rates are affected and not the real economic variables. Real economic variables include employment, consumption and real gross domestic product (GDP). Changes in money supply in an economy can either be a decrease o an increase in the supply of money, when this happens, the GDP, structure and other real variables of the economy are unaffected.

How does the Neutrality Of Money Work? 

There are some adjustments made to the modern versions of the neutrality of money theory, for instance, the modern version states that employment and output which are real variables of an economy can be affected by changes in money supply but only for a short period. The neutrality of money is otherwise called neutral money, this theory states that changes in money supply can affect the prices of goods and services and not real economic variables. Hence, the underlying structure and conditions of an economy do not change when a change occurs in the supply of money.

History and Meaning

Friedrich A. Hayek, an Austrian economist formally introduced the term neutrality of money was in 1931. After its introduction, the phrase was adopted by neoclassical and neo-Keynesian economists who applied it in the general equilibrium theory. The initial origin of the neutrality of money can be traced to the Cambridge tradition, this earliest version of the theory emerged between 1750 and 1870. When it was first used, the neutrality of money believes that changes in money supply cannot in any way affect economic output or employment, this later changed in the later centuries as it posited that these changes could affect output and employment in the short run.

Long-Run Money Neutrality

In reality, economists do not buy the idea of short-run money neutrality, rather, their position is that of long-run money neutrality. Macroeconomic theories underpin the assumption of long-run money neutrality, this is to show the long-term effect of economic and monetary policy on the economy. However, macroeconomists do not assume that changes in the supply of money would affect employment rate, output or real variables in the long-run. Criticisms There are some economists and economics schools that are not in favor of the neutrality of money both in its long-run and short-run forms. Generally, the Post-Keynesian school of economics and the Austrian school of economics are strong against the neutrality of money. Economists such as Paul Davidson, Ludwig von Mises, and many others are critics of this theory.

Related Topics

• Legal Tender
• Numismatics
• Gresham's Law
• Barter
• Double Coincidence of Wants
• Parity
• Functions of Money
• Medium of Exchange
• Unit of Account
• Store of Value
• Time Value of Money
• Standard of Deferred Payment
• Liquidity Preference Theory
• National Savings and Investment Identity
• Circular Flow of Money
• Commodity Money
• Gold Exchange Standard
• Bretton Woods System
• Fiat Money
• Money Supply
• M1 and M2 Money Supply
• Monetary Base
• Savings, Demand, and Time Deposits
• Banks
• How Do Banks Create Money? 
• Financial Intermediary
• Bank Balance Sheet
• Money Multiplier Formula
• Velocity of Money
• Multiplier Effect
• Quantity Equation of Money
• McCallum Rule
• Neutrality of Money
• Real Bills Theory
• Banking System?
• Central Bank
• Federal Reserve System
• Federal Open Market Committee (FOMC)
• Fed Balance Sheet
• Term Auction Facility
• Taylor Rule
• How is the Federal Reserve Bank Organized?
• What is Bank Regulation?
• CAMELS Rating
• FDIC
• CFPB
• Bank Supervision
• Bank Runs
• What is Deposit Insurance?
• Federal Deposit Insurance Corporation
• Lender of Last Resort
• Central Banks Carry Out Monetary Policy
• Open Market Operations
• Bank Reserve
• Discount Rate
• Federal Funds Rate
• Monetary Policy
• Contractionary and Expansionary Monetary Policy
• Loose vs Tight Monetary Policy
• Easy Monetary Policy 
• Accommodative Monetary Policy
• Dove & Hawk (Monetary Policy) - Explained
• Tight Monetary Policy - Explained
• Stabilization Policy
• Pushing on a String
• The Effect of Monetary Policy on Interest Rates
• Federal Funds Rate
• Gibson Paradox
• Vasicek Interest Rate Model
• Equation of Exchange (Economics)
• The Effect of Monetary Policy on Aggregate Demand
• Quantitative Easing
• Reserve Currency
• What are Excess Reserves?
• Unpredictable Movements of Velocity
• Central Banks - Unemployment and Inflation
• Inflation Targeting
• Fisher Effect
• Asset Bubbles and Leverage Cycles
• Countercyclical
• Money Capital Market
• Quantity Theory of Money
• Aggregate Expenditure Model
• IS-LM Model
• European Capital Market Institute