Long-run Neutrality of Money - Philosophical Concept | Alexandria
Long-run Neutrality of Money, a concept both fundamental and enigmatic in economics, posits that changes in the money supply only affect nominal variables like prices and wages in the long run, leaving real variables such as output and employment unchanged. It’s an idea often misunderstood as a claim of money's impotence, a simplification that masks a deeper, more nuanced reality.
The seeds of this theory can be traced back to the classical economists, although not explicitly stated as such since the concept of "long-run" was formalized much later. David Hume, in his 1752 essay "Of Money," eloquently observed that increases in the money supply only temporarily stimulate the economy; prices eventually adjust, negating any lasting real effects. This early articulation coincides with a period of burgeoning international trade and nascent central banking, a time ripe with economic speculation and debate about the nature of money itself.
The 20th century witnessed the formalization of long-run neutrality, particularly through the work of Milton Friedman and the monetarist school. Friedman's seminal work, "A Monetary History of the United States, 1867-1960," provided extensive empirical evidence supporting the theory. However, debates have continued. For instance, the persistence of nominal rigidities—sticky wages and prices—can delay the adjustment process, allowing monetary policy to have real effects even in the medium run. Furthermore, some scholars argue that repeated monetary shocks can alter expectations and behavior, leaving lasting scars on the real economy. Consider also the work of Knut Wicksell who highlighted the difference between the natural rate of interest and the actual rate of interest, a difference in which could also cause these fluctuations in Money Supply and the Real Economy.
Today, long-run neutrality remains a cornerstone of macroeconomic theory and policy. While central banks around the globe use monetary policy to manage inflation and stimulate economic growth, they do so with the understanding that money's influence on real outcomes is ultimately limited in the long run. Yet the precise nature and speed of that adjustment remain open questions, compelling economists to continuously refine their models and deepen their understanding of the intricate relationship between money and the real economy. Does this idea hold true during zero-interest-rate environments, or during times of extreme volatility, and crises, of which there are many? The search for a concrete answer will continue as global economies evolve.