Blog # 1: The Neutrality of Money

Blog # 1: The Neutrality of Money

Austin Grubb

April 8, 2014

Econ 122: Macroeconomics

            Money, it makes the world go round, right? The more you have, the more food you can buy, the bigger house you can live in, the faster car you can drive, and the better medical care you can receive. But money does not make the world go round, people do. Well, technically the sun and gravity makes the world go round, but it is people, not money, that take advantage of and make use of all of that energy that the sun has provided, and plants have stored for us.

            So it is people that grow crops, build houses and cars, and spend many years learning about medicine in school. But money is still important. Without money, all economic transactions would have to be completed thru barter, which means the “buyer” and “seller” would have to have a coincidence of wants. For example, if I raise chickens and I want a new bicycle, in order to get that new bicycle, I have to find a bicycle builder who happens to want chickens. So money was invented to represent a good or service that can universally be exchanged for another good or service of equal worth. Thus money becomes virtually any good or service, and that, makes it very powerful.

            Even so, money is not perfect. The paper bills we use for money only represent wealth, they do not equal wealth. They are only worth something because we as a society have agreed that they are worth something. For example, let’s say you want more money, if you are the government and you control the printing presses, then you can physically print out more money. But printing out more money doesn’t mean more crops are grown or more oil is pumped out of the ground. It just means that there is now more money floating around the economy to purchase the same amount of goods and services. This will create a greater demand for goods and services then the available producers can supply, and thus the prices of those goods and services will go up. This inflation of prices neutralizes the worth of the extra money that was added to the economy. Now, all of the money in the economy can buy the same number of goods and services, but because there is more of it, each bill can buy less.

            This effect is called the neutrality of money. It means that, in the long run at least, the size of the money supply is irrelevant to the number of goods or services that can be purchased. Even so, any time the money supply changes and/or inflation occurs, there are still winners and losers. In the above example, the government wins, because they get more money, and everyone else loses, because the money they have is now worth less. Sometimes, everyone loses. In cases of massive money supply increases, the resultant out of control inflation will discourage saving and investment in the future, because the money one holds, will be worthless by then.

            On the other side of the spectrum, if the money supply never increases, then in a growing economy, less money will be available to purchase an expanded product base. Prices could decrease to make the money worth what the economy can provide, or the economy could slow to match the money supply. This is where the Federal Reserve comes in. Their job is to monitor and adjust the monetary supply to keep inflation low and the economy strong.