Neutrality Of Money

Definition of '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.

Investopedia explains '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.



comments powered by Disqus
Hot Definitions
  1. Oil Reserves

    An estimate of the amount of crude oil located in a particular economic region. Oil reserves must have the potential of being extracted under current technological constraints. For example, if oil pools are located at unattainable depths, they would not be considered part of the nation's reserves.
  2. Joint Venture - JV

    A business arrangement in which two or more parties agree to pool their resources for the purpose of accomplishing a specific task. This task can be a new project or any other business activity. In a joint venture (JV), each of the participants is responsible for profits, losses and costs associated with it.
  3. Aggregate Risk

    The exposure of a bank, financial institution, or any type of major investor to foreign exchange contracts - both spot and forward - from a single counterparty or client. Aggregate risk in forex may also be defined as the total exposure of an entity to changes or fluctuations in currency rates.
  4. Organic Growth

    The growth rate that a company can achieve by increasing output and enhancing sales. This excludes any profits or growth acquired from takeovers, acquisitions or mergers. Takeovers, acquisitions and mergers do not bring about profits generated within the company, and are therefore not considered organic.
  5. Family Limited Partnership - FLP

    A type of partnership designed to centralize family business or investment accounts. FLPs pool together a family's assets into one single family-owned business partnership that family members own shares of. FLPs are frequently used as an estate tax minimization strategy, as shares in the FLP can be transferred between generations, at lower taxation rates than would be applied to the partnership's holdings.
  6. Yield Burning

    The illegal practice of underwriters marking up the prices on bonds for the purpose of reducing the yield on the bond. This practice, referred to as "burning the yield," is done after the bond is placed in escrow for an investor who is awaiting repayment.
Trading Center