Blog Post 1
Monetary Policy and Neutrality
Monetary policies have an influence on the prices of goods. If the Fed increases the money supply then there is said to be an increase in the long term prices of goods. "It is widely agreed that in the long run – after all adjustments in the economy have worked through – a change in the quantity of money in the economy will be reflected in a change in the general level of prices" (www.ecb.europa.eu). Although the economy will eventually be effected by the price of goods rising, any real variables will not be effected in the long run. "(Change in money) will not induce permanent changes in real variables such as real output or unemployment" (www.ecb.europa.eu). Changes in real variables such as the mentioned output and unemployment, are only effected by real factors. These factors can include but are not limited to technology, population growth, and famine.
Increasing the money supply only really has long term effects concerning the prices of goods. It has no bearing over the real variables because there is much more that comes into play. This is how money can often be seen as neutral. The Fed can increase or decrease the money supply to account for inflation, and the whole natural balance of the economy that is made up of other real variables will not be affected. "In the long run a central bank can only contribute to raising the growth potential of the economy by maintaining an environment of stable prices. It cannot enhance economic growth by expanding the money supply or keeping short-term interest rates at a level inconsistent with price stability. It can only influence the general level of prices" (www.ecb.europa.eu). This quality that states that changes in the monetary supply do not affect real variables in the long-run, is referred to as the neutrality of money. This concept is said to "underlie under almost all of macroeconomics, and has done so for hundreds of years" (http://www.themoneyillusion.com/ ).
In the short term monetary policy does not play a huge part. The real prices of things do shift a little bit when there is an increased money supply, but they go back to normal before there is ever any real impact. Only nominal prices undergo any sort of change and even then it is hard to manipulate the change to be good with the sole action of increasing the money supply. When the nominal prices do go up however, the nominal interest rate goes down. The nominal interest rate eventually causes the real interest rate to go down as well. The interest rate falling would induce more people to buy things, and thus the demand for goods would also go up. This would start a change reaction in the short-term that would eventually increase the nations output and the overall GDP. So monetary policy can, in the presence of neutrality, help get a country out of a recession faster than normal with the correct usage of increasing the money supply.
The monetary policy can be useful in helping countries get back on their feet. It can also be useful when a growing country has grown too much, too fast. Decelerating inflation and decreasing nominal prices are two ways that monetary policy being neutral helps. It is a good thing that money will always be neutral.
References
Scope of monetary policy. (n.d.). ECB:. Retrieved April 8, 2014, from https://www.ecb.europa.eu/mopo/intro/role/html/index.en.html
Sumner, S. (n.d.). Do you believe in the money multiplier?. TheMoneyIllusion ». Retrieved April 8, 2014, from http://www.themoneyillusion.com/?p=13852
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