The Neutrality of Money and Its Effect on Monetary Policy.

Stuart Hruza

Dr. Kassens

Econ122

4/8/2014

The idea that money is neutral is based around the concept that changes in money supply have no effect on aggregate demand and supply levels or real variables. In simpler terms changing money supply only has effect on the quantity money the fed puts into circulation, and how much it is worth, not unemployment levels etc. According to this idea, adding to or decreasing money supply will only change variables such as price and wage, changing proportionally with the changes in money supply.

If this concept holds true then monetary policy should be focused on keeping the value of the dollar held strong, while increasing with the growth rate of the nation. This means avoiding problems such as hyperinflation, where prices change so fast that what an item is being sold for in the morning is different than what it will be sold for at the close of the day. In cases such as hyperinflation Money supply can have indirect effects such as having to change menus to accurately adjust for price changes, where this menu change has direct printing cost.

This means that neutrality only holds true in certain circumstances, and that is even questioned by economist, as seen with a simple Google search of the principle. Thus monetary policy makes should be focused on how to make sure that neutrality is held as constant as possible. This means that the fed should keep the dollar from becoming worth less as well as becoming worth too much. As in most cases with everything in life there is a safe zone, in this case it’s where inflation increase rates are held pretty constant at a gradually level.

To conclude, how money is neutral depends on how intense the effect of the change in the money supply is. There are many “sticky” variables that money supply will effect if changed. It is neutral in the since that small changes will increase nominal variables, but it is not neutral when it comes to changes that are large, where it will effect costs of companies even adjusted for inflation rates. This leads to an obvious answer for the question of how it affects fiscal policy makers, their goal should be to level out the changes to a predictable level that is not too extreme as well as not stagnant so that we can adjust for economic growth.