what is neutrailty of money

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**Neutrality of money** is a concept in economics that suggests changes in the **money supply** only affect **nominal variables** (like prices, wages, and exchange rates) and have **no effect on real variables** (like real GDP, employment, or real consumption) in the **long run**.

In simpler terms, the neutrality of money posits that increasing or decreasing the money supply does not affect the real economy—meaning it does not change the actual output of goods and services, employment, or real purchasing power. Instead, it only impacts nominal values, such as price levels or nominal wages.

### Key Aspects of the Neutrality of Money:

1. **Short Run vs. Long Run**:
- In the **short run**, changes in the money supply can have real effects on the economy. For example, increasing the money supply can lower interest rates, stimulate investment, and boost output (this is the basis of expansionary monetary policy).
- In the **long run**, however, the economy adjusts, and the effects of changes in the money supply are thought to be "neutral." In the long run, output, employment, and real variables return to their natural levels, and the only lasting impact of an increase in money supply is a proportional increase in the overall price level (inflation).

2. **Classical Economics**:
- The idea of the neutrality of money is rooted in **classical economics**. Classical economists argue that the real economy—determined by factors such as labor, capital, technology, and preferences—operates independently of the money supply in the long run.
- Therefore, increasing the money supply does not increase the long-term productive capacity of the economy. It simply causes prices to rise proportionally.

3. **Monetarism and the Quantity Theory of Money**:
- **Monetarist economists**, such as Milton Friedman, also emphasize the neutrality of money. According to the **quantity theory of money**, if the velocity of money (the rate at which money changes hands) is constant and the economy is at full employment, an increase in the money supply will lead to a proportional increase in prices, leaving real output unaffected.
- The famous equation associated with this theory is:

\[
M \times V = P \times Y
\]

Where:
- **M** = Money supply
- **V** = Velocity of money (assumed constant)
- **P** = Price level
- **Y** = Real output (real GDP)

In this equation, if the money supply (M) increases, and velocity (V) and real output (Y) remain constant, the price level (P) must increase proportionally.

4. **Real Variables vs. Nominal Variables**:
- **Real variables**: These include quantities like real GDP, real wages, and employment levels, which are adjusted for inflation and reflect the actual physical output or value in terms of purchasing power.
- **Nominal variables**: These are measured in monetary terms and are not adjusted for inflation, such as nominal GDP, nominal wages, and price levels.

Under the neutrality of money, changes in the money supply affect only nominal variables (like price levels) and do not change real variables (like real output or employment) in the long run.

### Examples of Neutrality of Money:
- If the money supply in an economy doubles, the **classical view** suggests that in the long run, all prices, wages, and other nominal variables will also double. However, the real purchasing power of individuals, the amount of goods and services produced, and the levels of employment will remain unchanged.
- This means that while the price of bread, cars, and wages would all increase proportionally, the actual quantity of bread baked or cars produced remains the same, and workers are not necessarily better off in real terms.

### Non-Neutrality of Money in the Short Run:
While money is considered neutral in the long run, it is often **non-neutral in the short run**. This non-neutrality occurs because of factors such as **sticky prices and wages**, imperfect information, and short-run adjustments in economic behavior. For instance:
- **Sticky prices and wages**: Prices and wages do not adjust instantly to changes in the money supply due to contracts, norms, and other frictions. As a result, changes in the money supply can affect real output and employment in the short run by influencing demand and production.
- **Monetary policy**: Central banks use monetary policy (e.g., lowering interest rates or increasing the money supply) to stimulate or cool down the economy in the short run, influencing real variables like unemployment and real GDP.

### Superneutrality of Money:
A related concept is **superneutrality of money**, which is a stronger version of the neutrality of money. It suggests that not only the **level** of the money supply but also the **growth rate** of the money supply has no effect on real variables in the long run. In this view, changing the rate of money supply growth does not affect real economic growth, real wages, or real interest rates over the long term—only the inflation rate is affected.

### Criticisms and Exceptions to the Neutrality of Money:
- **Keynesian Economics**: Keynesians argue that money is not neutral in the short run, and in some cases, not in the long run either. They emphasize that changes in the money supply can have real effects, especially when the economy is below full employment, as monetary policy can influence aggregate demand, investment, and consumption.
- **Expectations and Inflation**: Changes in the money supply may influence inflation expectations, which can, in turn, affect real economic decisions like consumption and investment, potentially making money non-neutral.
- **Hysteresis**: In some cases, a prolonged period of unemployment or economic slack can have permanent effects on the labor force or productive capacity, leading to a situation where money is not fully neutral, even in the long run.

### Summary:
- The **neutrality of money** suggests that changes in the money supply only affect nominal variables (like prices and wages) and have no impact on real variables (like output or employment) in the **long run**.
- In the **short run**, money can be non-neutral, as changes in the money supply can influence real economic activity, prices, and unemployment due to factors like sticky prices and wages.
- **Monetary policy** can have real effects in the short run, but in the long run, the economy is expected to adjust, leaving money neutral in terms of real economic variables.

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