Neutrality Of Money

What is 'Neutrality Of Money'

An economic theory that states that changes in the aggregate money supply only affect nominal variables, rather than real variables; therefore, an increase in the money supply would increase all prices and wages proportionately, but have no effect on real economic output (GDP), unemployment levels, or real prices (prices measured against a base index). The neutrality of money is based on the idea that changing the money supply will not change the aggregate supply and demand of goods, technology or services. It was a cornerstone of classical economic thought, but modern-day evidence suggests that neutrality of money does not fully apply in financial markets.

BREAKING DOWN 'Neutrality Of Money'

The neutrality of money is considered a plausible scenario over long-term economic cycles, but not over short time periods. In the short term, changes in the money supply seem to affect real variables like GDP and employment levels, mainly because of price stickiness and imperfect information flow in the markets.

Central banks like the Federal Reserve monitor the money supply closely, and step in (through open market operations) to change the money supply when conditions deem it necessary. Their actions indicate that short-term money supply changes can and do affect real economic variables.

Economists generally feel that certain elements like wages have stickiness to them; employers can raise wages but lowering them is nearly impossible in a practical sense. Also, companies are reluctant to make minor changes to prices just because of a slight change in the money supply. Effects like this undermine the conclusions that can be reached from short-term analysis of the neutrality of money.

RELATED TERMS
  1. Supply

    A fundamental economic concept that describes the total amount ...
  2. Money Supply

    The entire stock of currency and other liquid instruments in ...
  3. Aggregate Supply

    The total supply of goods and services produced within an economy ...
  4. Change In Supply

    A term used in economics to describe when the suppliers of a ...
  5. Supply Shock

    An unexpected event that changes the supply of a product or commodity, ...
  6. Quantity Supplied

    A term used in economics to describe the amount of goods or services ...
Related Articles
  1. Economics

    Explaining Aggregate Supply

    Aggregate supply is the total supply of goods and services an economy produces in a given time period.
  2. Economics

    How Does Money Supply Affect Interest Rates?

    A larger money supply lowers market interest rates, while a smaller supply tends to raise them.
  3. Economics

    How Do Central Banks Inject Money Into The Economy?

    Central banks inject money into the banking system, and remove money from it, through monetary policy actions.
  4. Economics

    Understanding Money Supply

    Money supply – also called money stock -- refers to the total amount of currency and other liquid financial products in an economy at a particular time.
  5. Economics

    Macroeconomics: Money And Banking

    By Stephen Simpson TMoney can be thought of as any good that is widely used or accepted in the transfer of goods and services. Today, there are three common forms of money in use. Commodity ...
  6. Economics

    How Does China Manage Its Money Supply?

    Here's how the Central Bank of China manages its currency rates and the money supply.
  7. Fundamental Analysis

    What Is the Quantity Theory of Money?

    Take a look at the tenets, assumptions and challenges of monetarism's principal theory.
  8. Options & Futures

    Explaining The World Through Macroeconomic Analysis

    From unemployment and inflation to government policy, learn what macroeconomics measures and how it affects everyone.
  9. Economics

    Law of Supply

    The law of supply is one of the most fundamental principles in microeconomics. According to the law of supply, for all other things remaining constant, the higher the price of a good or service, ...
  10. Personal Finance

    Will You See Higher Wages In 2015?

    It's been a few years into the economic recovery from the Great Recession, and the employment picture has been rocky.
RELATED FAQS
  1. What is the correlation between money supply and GDP?

    Read about the two-way correlation between the total amount of money circulating in the economy and gross domestic product, ... Read Answer >>
  2. How does the law of supply and demand affect monetary policy in the United States?

    Learn about how the law of supply and demand affects monetary policy in the United States. Changing interest rates leads ... Read Answer >>
  3. How is money supply used in monetary policy?

    Learn about the three components of the Federal Reserve's monetary policy. Understand how these three components use the ... Read Answer >>
  4. What's the difference between regular supply and demand and aggregate supply and ...

    Understand how businesses use supply and demand and aggregate supply and demand to forecast economic activity. Learn about ... Read Answer >>
  5. Why do supply shocks occur and who do they negatively affect the most?

    Take a deeper look at the nature of supply shocks, an economic phenomenon that dramatically changes the equilibrium level ... Read Answer >>
  6. How does money supply affect interest rates?

    Read about the link between the supply of money and market interest rates, and find out why money supply alone can't explain ... Read Answer >>
Hot Definitions
  1. Physical Capital

    Physical capital is one of the three main factors of production in economic theory. It consists of manmade goods that assist ...
  2. Reverse Mortgage

    A type of mortgage in which a homeowner can borrow money against the value of his or her home. No repayment of the mortgage ...
  3. Labor Market

    The labor market refers to the supply and demand for labor, in which employees provide the supply and employers the demand. ...
  4. Demand Curve

    The demand curve is a graphical representation of the relationship between the price of a good or service and the quantity ...
  5. Goldilocks Economy

    An economy that is not so hot that it causes inflation, and not so cold that it causes a recession. This term is used to ...
  6. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
Trading Center