Updated Jan 8, 2023 Monetary neutrality (a.k.a., the neutrality of money theory) is an economic concept that states that changes in the money supply have no effect on real economic variables such as output or employment. That means, according to this concept an increase in the money supply does not lead to an increase in economic activity. The theory of the neutrality of money was first introduced by economist Friedrich A. Hayek, in 1931. To illustrate this concept, let’s look at a hypothetical economy with a fixed money supply. In this economy, the money supply is constant, and the central bank does not intervene in the market. As a result, the money supply does not change, and the economy is in its long-run equilibrium (i.e., aggregate demand equals aggregate supply). Now, let’s assume the central bank decides to increase the money supply by 10%. According to the principle of money neutrality, this increase in the money supply should, in theory, lead to no increase in economic activity because it has no effect on the economic equilibrium. However, modern versions of this theory suggest that money might not be perfectly neutral in the short run, because it increases prices and thereby affects production and consumption decisions. Neutrality is still assumed in the long run, though. Monetary neutrality is an important concept for economists, central banks and policy-makers. It helps them to understand the effects of changes in the money supply on the economy. In particular, it helps them to better understand the consequences of changes in the money supply on price levels and economic output. This is important because it allows them to make informed decisions about monetary policy and helps them to avoid making mistakes that could have a negative impact on the economy and society as a whole.Definition of Monetary Neutrality
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Why Monetary Neutrality Matters
Macroeconomics