Neutrality of Money

Neutrality of Money

Introduction

In economics, neutrality of money is the idea that a change of shares of money affects only nominal variables in the economy such as prices, wages and exchange rates, no effects over real variables like GDP, employment, and consumption. This is an important idea in classical economics and is related to classical dichotomy. The neutrality of money implies that the central bank can not affect the real economy (e.g., the number of jobs, the size of GDP, and the amount of investment) by printing money. Any increase in money supply would be immediately offset by an equal rise in prices and wages. (Shaw, 1985, 15)

What is the new classical economic theory? The theory of real business cycle refers to the new classical school, as the analysis of economic fluctuations is carried out in it with the original assumptions of the classical model, especially on a perfect price flexibility and neutrality of money. Go to this school, in its broadest sense and include a number of other exercises, which unites opposition to the dominating in the 60-ies.

Flexibility of wages and prices

Real business cycle theory assumes that prices and wages vary so as to maintain a constant balance of the market, and that the analysis of economic fluctuations assumption of rigidities in prices and wages is not required. In addition, according to its proponents, coming out of price flexibility methodology ensures the unity of the micro-and macroeconomic analysis and so versatile: after all, in microeconomics prices play a key role in establishing economic equilibrium. Proponents of the theory of real business cycle are also believed that the same premise should lie at the heart of macroeconomic analysis of oscillations. (Mervyn, 2000, 63)

Refuting this argument, opponents of this theory cite a number of examples of rigidities in prices and wages... That's it; they associate the existence of unemployment and non-neutrality of money.

Discussion and Analysis

The neutrality of money is the proposition that changes in money supply does not affect real variables. Doubling the money supply causes prices nominal bending. Similarly, the real wage does not change, so that:

The workload does not change offered

The quantity of labor demanded does not change

The total employment work does not change

The same applies to the use of capital or other resources. Since the use of all resources remains unchanged, total production is not affected by the money supply. Most economists think that the dichotomy and the neutrality of money described the economy in the long term.

. However, short-term changes in monetary variables can have important effects on real variables.

Rationality related approach suggests that small contractions in the money supply are not taken into consideration when people sell their homes or looking for work, and therefore they spend more time looking for a contract that made no monetary contraction. In addition, the floor on nominal wage changes imposed by most companies is observed to be zero, an arbitrary number by the theory of neutrality, but a very real ...