<blockquote>
  <p>Can monetary policy affect potential output growth?</p>
</blockquote>

<p>Yes. Otherwise, central banks would be indifferent to quantitative easing and other measures.</p>

<blockquote>
  <p>how is this consistent with the neoclassical thesis's of money neutrality in the long run?</p>
</blockquote>

<p>It is not. The <a href="https://www.investopedia.com/terms/n/neutrality_of_money.asp" rel="nofollow noreferrer">premise</a> that "<em>new money neither creates nor destroys machines</em>" sounds accurate only <em>in isolation</em>. But in the real world, companies bind themselves to financial (as well as fiscal) obligations which are in terms of <em>nominal</em> variables.</p>

<p>Certain monetary policies may render those companies cash-strapped, thereby triggering liquidity crises, bankruptcies, higher cost of financing, emigration of skilled workforce, and other effects. Altogether, this may result in structural changes in the economy.</p>

<p>Thus, while the thesis assumes that the <a href="https://www.investopedia.com/terms/n/neutrality_of_money.asp" rel="nofollow noreferrer">aggregate supply curve is vertical</a>, it misses the logical notion that this curve may shift to the left or to the right in the long run.</p>

CC BY-SA 4.0
2019-03-15T10:05:36.997Z
This is not accurate. Because we need to differentiate between the short run, where rigidities occur leading monetary policy to affect real variables. Therefore, money is not neutral in the short run. On the other hand, in the long run, the economy converge to steady state and prices/wages fully adjust leading monetary policy to only affect prices in the long run.
Ramy Oraby
CC BY-SA 4.0
2019-03-15T10:06:02.323Z
In that sense, monetary policy only reduce the deviation from equilibrium values leading to less severe cycles and to macroeconomic stability.
Ramy Oraby
CC BY-SA 4.0
2019-03-15T10:06:09.360Z
Empirically, if money is not neutral in the long run, how would you explain the subdued potential output growth in advanced economies despite the unprecedented monetary policy easing?
Ramy Oraby
CC BY-SA 4.0
2019-03-15T12:57:34.363Z
@RamyOraby By assuming a "*convergence to steady state*" you seem to have a preconceived answer to your own question, but it ignores the realistic, possible effects I outlined (defaults, bankruptcies, emigration, etc) which can affect the long term composition of an economy. Quantitative Easing policies cannot secure effectiveness in preventing the new money from flocking to foreign, financial, and commodity markets (instead of staying in the real economy). And without QE, the number, severity, and speed of bankruptcies would have been much greater than they were in/upon the Great Recession.
Iñaki Viggers
CC BY-SA 4.0
2019-03-14T13:06:53.450Z
2019-03-14T13:06:53.450Z
Iñaki Viggers
<p>Can monetary policy affect potential output growth? And if yes, how is this consistent with the neoclassical thesis's of money neutrality in the long run?</p>

<monetary-policy>
Monetary policy and potential output growth
Ramy Oraby
# Monetary policy and potential output growth

(Asked by: username_0 on 2019-03-13)

Can monetary policy affect potential output growth? And if yes, how is this consistent with the neoclassical thesis's of money neutrality in the long run?

**Tags:** monetary-policy

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## 1 answers

### Answer by username_1 on 2019-03-14. Score: 1

> Can monetary policy affect potential output growth?

Yes. Otherwise, central banks would be indifferent to quantitative easing and other measures.

> how is this consistent with the neoclassical thesis's of money neutrality in the long run?

It is not. The [premise](https://www.investopedia.com/terms/n/neutrality_of_money.asp) that "*new money neither creates nor destroys machines*" sounds accurate only *in isolation*. But in the real world, companies bind themselves to financial (as well as fiscal) obligations which are in terms of *nominal* variables.

Certain monetary policies may render those companies cash-strapped, thereby triggering liquidity crises, bankruptcies, higher cost of financing, emigration of skilled workforce, and other effects. Altogether, this may result in structural changes in the economy.

Thus, while the thesis assumes that the [aggregate supply curve is vertical](https://www.investopedia.com/terms/n/neutrality_of_money.asp), it misses the logical notion that this curve may shift to the left or to the right in the long run.

> **Comments:**
> **username_0**: This is not accurate. Because we need to differentiate between the short run, where rigidities occur leading monetary policy to affect real variables. Therefore, money is not neutral in the short run. On the other hand, in the long run, the economy converge to steady state and prices/wages fully adjust leading monetary policy to only affect prices in the long run.  
> **username_0**: In that sense, monetary policy only reduce the deviation from equilibrium values leading to less severe cycles and to macroeconomic stability.  
> **username_0**: Empirically, if money is not neutral in the long run, how would you explain the subdued potential output growth in advanced economies despite the unprecedented monetary policy easing?  
> **username_1**: @RamyOraby By assuming a "*convergence to steady state*" you seem to have a preconceived answer to your own question, but it ignores the realistic, possible effects I outlined (defaults, bankruptcies, emigration, etc) which can affect the long term composition of an economy. Quantitative Easing policies cannot secure effectiveness in preventing the new money from flocking to foreign, financial, and commodity markets (instead of staying in the real economy). And without QE, the number, severity, and speed of bankruptcies would have been much greater than they were in/upon the Great Recession.  

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