Is Money Neautral?

Haley Halibozek
ECON 122
Dr. Kassens
4/8/14

Money neutrality is defined as "the proposition that changes in the money supply do not affect real variables," by Mankiw in Chapter 17. Through reading this chapter, readers learn that real variables include production, employment, real wages, and real interest rates. For example, changing the money supply will only affect the quantity of money, and the worth of it used by the Fed. With this in mind, unemployment rates for example will not be affected. Decreasing or adding money supply will change only nominal variables including wages and prices. Under this theory of money neutrality, monetary changes for real variables are irrelevant. However, changes in the money supply will affect nominal variables in the future. In short terms, changes in the money supply affect real variables like GDP and employment levels primarily because of price stickiness and the ever-changing flow in markets.
Many economists believe that elements such as wages are sticky. Since employers can raise wages and it is difficult for them to lower them. In addition, companies refuse to make small changes to prices because of the changes it will produce in the money supply. These changes support the short-term theories of the neutrality of money. 

Monetary Policy, if successful, should ensure money neutrality. The Austrian economist Friedrich Hayek supported this idea of "a stage of equilibrium which are described by general economic theory," in Prices and Production. He uses the principles of a Walrasian general equilibrium to further expand on his opinion. "The monetary policy should not distort relative prices and hence monetary policy should be conducted in a way to ensure that relative prices are as close to possible to what they would have been in a world with no money and no frictions." (Hayek) This relates to the focal point of keeping the value of the dollar strong in order to avoid hyperinflation and future recessions. 
The Fed's monetary policy should establish a consistent growth rate for the money supply in order to have future economic stability. Mankiw is able to credit this view to the Fisher Effect. It is defined as the one-for-one adjustment of the nominal interest rate to the inflation. (Mankiw) This only further supports the importance of focusing monetary policy to nominal variables rather than real variables. Real interest rates will be left unchanged in the long-run due to this principle of money neutrality. 
Central banks like the Federal Reserve (Fed) keep track of the money supply closely. They are able to intervene through open market operations in order to change the money supply when it is evidently necessary. 
To conclude, money neutrality helps nations see where they need to improve in order to have a thriving economy. This can be useful to countries such as Zimbabwe and Ukraine to return to homeostasis. Money neutrality can provide aid to countries that have grown significantly in a short amount of time. Keeping the risks of hyperinflation low and decreasing nominal prices enable improvement in economies through neutral monetary policy. The final objective is to achieve an economic equilibrium of output which can be reached with money staying neutral. 


References

Mankiw, Gregory. (2012). Principles of Macroeconomics: Sixth Edition. Mason, OH: South-Western Cengage Learning. 

Monetary Policy.  Investopedia Online. Retrieved from: http://www.investopedia.com/terms/m/monetarypolicy.asp

Neutrality of Money. Investopedia Online. Retrieved from: http://www.investopedia.com/terms/n/neutrality_of_money.asp

“Money neutrality” – normative rather than positive. Lars Christensen. Retrieved 

                from: http://marketmonetarist.com/2012/10/13/money-neutrality-normative-rather-than-positive/