Neutrality of Money
What it is:
The neutrality of money is a theory stating that changes productivity.supply only affect prices and wages rather than overall economic
How it works (Example):
For example, when the FederalCommittee (an agency within the Federal Reserve) purchases U.S. in the , it gives to the sellers. The sellers these payments at their local banks. Because the Federal Reserve requires banks to maintain a certain percentage of these in reserve, the banks are free to lend most of these new to other bank customers and earn interest. These customers in turn the proceeds in their own bank accounts, and the process continues indefinitely. Thus, every dollar of securities that the Federal Reserve buys increases the supply by several dollars.
There are only two things to do with money: save it or spend it. Accordingly, some of the "new" money land in the hands of retailers, service providers, new employees, etc. This increase in the demand for goods and services drive the prices of those goods and services up. The increased demand may also encourage employers to hire more employees, and the demand for more employees also drives wages up.in the (from the Treasury repurchase) land in bank accounts, and some of the new
However, the neutrality of money theory says that the ripple effect essentially stops there. In other words, the repurchase would not increase theof the 's employees and may not increase the country's .
Why it Matters:
The theory of the neutrality of money argues thatis a "neutral" that has no real effect on economic equilibrium. Monetary supply may be able to change how much things cost, says the theory, but it can't change the fundamental nature of the itself. The theory is a component of classical , but it has less relevance and more controversy today. In particular, some argue that the theory really only "works" over the long , if at all.