By Thorsten Polleit
Today's mainstream macroeconomic theory typically focuses on aggregate consequences resulting from policy measures, such as the effect on output and prices of a rise in the money stock. One crucial assumption is that money is neutral.
Money is said to be neutral if an increase in the money stock leads to a proportional and permanent increase in prices and leaves real economic activity (such as output, investment and employment) unaffected. So, a rise in the steady growth rate of the money stock is said to lead to an identical rise in the steady growth rate of prices.
The hypothesis of the neutrality of money is mostly assumed to hold in the long term, while in the short-to-medium term the idea is that a rise in the money stock may well affect economic activity. This is largely attributable to surprise (and transaction-cost) effects.
For instance, an unexpected rise in the money stock induces changes in relative prices and therefore affects consumption and investment. Eventually, however, market agents adjust their dispositions (wages, contracts, etc.) to higher prices, and economic activity returns to its original level. So, the new money increases prices, but it does not increase production.
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Today's mainstream macroeconomic theory typically focuses on aggregate consequences resulting from policy measures, such as the effect on output and prices of a rise in the money stock. One crucial assumption is that money is neutral.
Money is said to be neutral if an increase in the money stock leads to a proportional and permanent increase in prices and leaves real economic activity (such as output, investment and employment) unaffected. So, a rise in the steady growth rate of the money stock is said to lead to an identical rise in the steady growth rate of prices.
The hypothesis of the neutrality of money is mostly assumed to hold in the long term, while in the short-to-medium term the idea is that a rise in the money stock may well affect economic activity. This is largely attributable to surprise (and transaction-cost) effects.
For instance, an unexpected rise in the money stock induces changes in relative prices and therefore affects consumption and investment. Eventually, however, market agents adjust their dispositions (wages, contracts, etc.) to higher prices, and economic activity returns to its original level. So, the new money increases prices, but it does not increase production.
Continue reading...
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