Jessica
Hopkins
Dr.
Kassens
ECON
122
Tuesday,
April 8, 2014
Neutral Money
For many years, people used a
bartering system in order to receive goods and services. This was a hard system
to follow. When a person wanted a good or service, they needed to have a
specific good or service that the provider wanted to trade for. Finding people
to trade for the needed good was very time consuming. Therefore, money was
created to make trading easier and less time consuming. According to Mankiw (2012), money is the most
liquid assets that are used to purchase goods and services regularly (p. 324).
Money is a key part in the economy.
When money supply changes, it affects the economy. For example, Mankiw (2012)
states that when too much money is made, the economy goes under inflation (p.
331).
According to Bilo and Wagner (2012),
neutral money, however, is supposed to help keep the economy at a long-run
equilibrium (p. 1). Mankiw (2012) defines monetary neutrality as when money
supply changes, the real variables do not change, only the nominal variables
change (p. 354). Some of the real variables that remain unchanged, for example,
is quantity of labor supplied, quantity of labor demanded, and total
employment. Haughton and Iglesias (2013) agree and say that when the money
supply increases, it only increases the rate of inflation. With the help of the
market forces, the economy reaches a long-run equilibrium point and eventually
will increase money stock (p. 26).
Mankiw (2012) argues that monetary
neutrality is not realistic. This is because in the short-run, a change in
money supply will cause more complexity which makes things more confusing.
Therefore, monetary changes do affect real variables in a short-run (p. 354). However,
Masciandaro (2014) says that as a market becomes more stable, the more risk the
monetary policy has in only inflation.
One application of monetary
neutrality is the Fisher effect. Mankiw (2012) defines the Fisher effect as an
adjustment of the nominal interest rate and the inflation rate. He also uses an
equation where nominal interest rate equals the sum of the real interest rate
and the inflation rate that shows how the monetary neutrality is in effect with
monetary policy (p. 359). Since the real interest rate is a part of the sum for
nominal interest rate, it does not get affected by the change in inflation
rate. Therefore, this shows that the real variables are not being changed since
the real interest rate is not affected. This relates to the previous definition
of monetary neutrality.
References
Bilo,
S., and Wagner R. E. (2012). Neutral money: Historical fact or analytical
artifact. GMU Working Paper in Economics: No. 12-37, 1-27. http://dx.doi.org/10.2139/ssrn.2139373
Haughton,
A. Y., and Iglesias, E. M. (2013). Assessing long-run money neutrality in
monetary unions. International Journal of Finance and Economics, 18 (1), 25-50.
doi: 10.1002/ijfe.455 http://eds.a.ebscohost.com/ehost/pdfviewer/pdfviewer?sid=20e3047a-0bdb-47d7-9ea6-743d6997172e%40sessionmgr4004&vid=8&hid=4111
Mankiw, G. N. (2012). Principles of macroeconomics.
Mason, OH: South-Western Cengage Learning.
Masciandaro, D. (2014). Bankers, bureaucrats, and
central bank politics: The myth of neutrality Journal of Economic Literature,
52 (1), 223-226. http://eds.b.ebscohost.com/ehost/detail?sid=a00e3fbd-d1d8-4cca-8c43-33b36be44f76%40sessionmgr112&vid=6&hid=116&bdata=JnNpdGU9ZWhvc3QtbGl2ZQ%3d%3d#db=eoh&AN=1419497
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