Neutrality Of Money
Candlefocus EditorThe concept of money neutrality was first described by British economist Alfred Marshall in the late 19th century. Later, the Austrian school of economics, particularly the works of Hayek and former President of the Austrian National Bank, Eugen von Böhm-Bawerk, argued that the amount of money in an economy would eventually affect only relative prices, while the goal of the “fake” economy--the amount of output and real capital accumulation--would remain stable.
The theory of money neutrality espouses the belief that changes in the money supply will eventually lead to higher prices, but no substantial structural change that would lead to either an increase or decrease in output and wealth. This is tied to the monetarist belief that in the long run, the value of money can always be held constant in a free market economy. However, this does not mean that the purchasing power and value of money will always remain constant over time, as economists and financial experts are aware that the inflation rate, interest rates, and prices of goods and services constantly fluctuate.
The neutrality of money, then, suggests that any shifts in the money supply will only affect the relative price of goods and services in comparison to each other, while leaving other economic factors such as production and saving unaffected. Hayek himself later revised his original stance on the neutrality of money in the 1940s, claiming that costs of production and the capital structure of an economy could be affected by monetary policies.
Today, most economists agree that money neutrality does not exist in practice, but can be an effective concept to consider over a long timeframe. While changes in money supply can have an immediate and significant impact on the exchange rates of goods, the long-term effects are not as pronounced and are difficult to predict. Monetary policies, such as inflation and quantitative easing, can have an immediate effect on the relative prices of goods and services, but given enough time these effects will eventually even out. However, this implies that money neutrality should not be used as an ideal to operate economic policy on its own, but rather as a factor to be taken into consideration when understanding the overall economy.