<p>If one believes that there is a single equilibrium, and that markets will find it whatever the starting position, then money must be neutral in the long run. A monetary intervention, in that world, is a temporary perturbation that will get traded away to zero eventual impact, as everything returns to equilibrium.</p>

<p>It is likely that neither of those underlying assumptions are true.</p>

<p>However, they are commonly made to simplify the analysis.</p>

<p>Some economists fall into the trap of making the assumptions to simplify the analysis, but then internalising those assumptions as being how the world actually works.</p>

CC BY-SA 4.0
2018-07-23T08:52:46.767Z
2018-07-23T14:41:23.233Z
2018-07-23T14:41:23.233Z
410 gone
<p>There are multiple ways that a central bank can resort to apply its designated monetary policy. The most common one is called "open market operations (omo)", which is basically selling/buying government securities to/from private individuals or organizations. Through these operations, central bank affects the level of cash reserves in the banking system since it deposits/withdraws payments for these government securities to/from the banking system. When cash reserves in the banks go up -by central bank buying government securities-, these banks decrease their interest rate to deplete the extra added cash reserves, and the vice-versa.</p>

<p>As you can see, in this mechanism the only price that is changed "directly" by central bank is the price of government securities. Once the cash reserves in the banking system reaches its targeted level, the probability that the general price level in a specific market will be affected is equal for almost all markets. Thus the operations of central bank does not aim at specific markets, alterations in the interest rates affect the whole economy equally by average.</p>

<p>There are tons of literature, both theoretical and empirical, focusing on the neutrality of money. You can also search them via Google Scholars.</p>

CC BY-SA 4.0
2018-07-23T08:56:25.573Z
"Once the cash reserves in the banking system reaches its targeted level, the probability that the general price level in a specific market will be affected is equal for almost all markets." - is that really true though? Is there good empirical evidence for this? And even if the probability of the price in any one market being affected is the same across all markets, which I don't think is true btw, does monetary policy consistently have the effect of multiplying the price in every single market by a common factor? In that case Id put some truck in money neutrality. But I don't think its true.
Steven
CC BY-SA 4.0
2018-07-23T07:00:53.393Z
2018-07-23T07:00:53.393Z
Osman Bulut
<p>I'm more of a micro guy, so take what I'm saying with a grain of salt.</p>
<p>Suppose there's a monetary policy shock. Because of nominal rigidities and credit market imperfections output, prices change. The price level eventually settles in its trajectory and output does the same.</p>
<p>I guess what I'm trying to do is to ask you a question: how can money <em>not</em>
be neutral? How can a Central Bank change, only through policy, change output in the long run?</p>
<p>It that were the case, wouldn't every single country in the world be rich by now?</p>

CC BY-SA 4.0
2018-07-22T21:11:54.257Z
Do you mean how can money not be neutral in the long run? If the central bank engages in some market transactions, this inevitably changes prices in the economy, and this clearly has real effects - people do not buy the same stuff as they did before.
I struggle to see how monetary policy couldn't have real effects in the long run.
Steven
CC BY-SA 4.0
2021-10-02T17:03:58.523Z
Over time, the total amount of output is invariant with regards to this net transfer of wealth. Money being neutral in the long run *just means* central banks have no power on output in the long run. In a weaker statement, it means central banks can only decrease output in the long run, not increase it.
Pedro Cavalcante
CC BY-SA 4.0
2021-10-02T17:06:11.873Z
Suppose central banks _could_ change output in the long run.

Well then, why is the world so poor still, if most of Latin American and Asian central banks have engaged in decades of irresponsible expansionary monetary policy? 

How, in such a scenario, would the effect the transmitted. CBs would lower interest rates and then what? People invest more and that's it? No trade-offs, no relative price changes, no updating of expectations?
Pedro Cavalcante
CC BY-SA 4.0
2021-10-02T17:08:43.597Z
Lucas, for all his problems and theoretical shortcomings, nailed it in his 1972 paper _Expectations and the Neutrality of Money_.
Pedro Cavalcante
CC BY-SA 4.0
2018-07-22T19:55:11.623Z
2021-10-02T17:01:50.857Z
2021-10-02T17:01:50.857Z
Pedro Cavalcante
<p>If a central bank carried out monetary policy that consisted of multiplying each person's wealth by a common factor, I would find it plausible that all prices would get multiplied by the same factor and there would be approximately no real effects.</p>

<p>However, this is not how central banks carry out monetary policy. They print money and engage in market transactions that target certain prices. To me it does not seem plausible that this has no real effects, in the long run or the short run. </p>

<p>My question is, why do many economists believe that money is neutral in the long run? Do they take the quantity theory of money as proof that money is neutral in the long run? Is there particular empirical evidence, or influential papers that have convinced many economists that money is neutral in the long run?</p>

<monetary-policy><money><quantity-theory-of-money>
Why do many economists believe that money is neutral in the long run?
Steven
# Why do many economists believe that money is neutral in the long run?

(Asked by: username_0 on 2018-07-22)

If a central bank carried out monetary policy that consisted of multiplying each person's wealth by a common factor, I would find it plausible that all prices would get multiplied by the same factor and there would be approximately no real effects.

However, this is not how central banks carry out monetary policy. They print money and engage in market transactions that target certain prices. To me it does not seem plausible that this has no real effects, in the long run or the short run.

My question is, why do many economists believe that money is neutral in the long run? Do they take the quantity theory of money as proof that money is neutral in the long run? Is there particular empirical evidence, or influential papers that have convinced many economists that money is neutral in the long run?

**Tags:** monetary-policy, money, quantity-theory-of-money

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## 3 answers

### Answer by username_1 on 2018-07-23. Score: 2

If one believes that there is a single equilibrium, and that markets will find it whatever the starting position, then money must be neutral in the long run. A monetary intervention, in that world, is a temporary perturbation that will get traded away to zero eventual impact, as everything returns to equilibrium.

It is likely that neither of those underlying assumptions are true.

However, they are commonly made to simplify the analysis.

Some economists fall into the trap of making the assumptions to simplify the analysis, but then internalising those assumptions as being how the world actually works.


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### Answer by username_2 on 2018-07-23. Score: 1

There are multiple ways that a central bank can resort to apply its designated monetary policy. The most common one is called "open market operations (omo)", which is basically selling/buying government securities to/from private individuals or organizations. Through these operations, central bank affects the level of cash reserves in the banking system since it deposits/withdraws payments for these government securities to/from the banking system. When cash reserves in the banks go up -by central bank buying government securities-, these banks decrease their interest rate to deplete the extra added cash reserves, and the vice-versa.

As you can see, in this mechanism the only price that is changed "directly" by central bank is the price of government securities. Once the cash reserves in the banking system reaches its targeted level, the probability that the general price level in a specific market will be affected is equal for almost all markets. Thus the operations of central bank does not aim at specific markets, alterations in the interest rates affect the whole economy equally by average.

There are tons of literature, both theoretical and empirical, focusing on the neutrality of money. You can also search them via Google Scholars.

> **Comments:**
> **username_0**: "Once the cash reserves in the banking system reaches its targeted level, the probability that the general price level in a specific market will be affected is equal for almost all markets." - is that really true though? Is there good empirical evidence for this? And even if the probability of the price in any one market being affected is the same across all markets, which I don't think is true btw, does monetary policy consistently have the effect of multiplying the price in every single market by a common factor? In that case Id put some truck in money neutrality. But I don't think its true.  

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### Answer by username_3 on 2018-07-22. Score: -1

I'm more of a micro guy, so take what I'm saying with a grain of salt.

Suppose there's a monetary policy shock. Because of nominal rigidities and credit market imperfections output, prices change. The price level eventually settles in its trajectory and output does the same.

I guess what I'm trying to do is to ask you a question: how can money *not*
be neutral? How can a Central Bank change, only through policy, change output in the long run?

It that were the case, wouldn't every single country in the world be rich by now?

> **Comments:**
> **username_0**: Do you mean how can money not be neutral in the long run? If the central bank engages in some market transactions, this inevitably changes prices in the economy, and this clearly has real effects - people do not buy the same stuff as they did before. I struggle to see how monetary policy couldn't have real effects in the long run.  
> **username_3**: Over time, the total amount of output is invariant with regards to this net transfer of wealth. Money being neutral in the long run *just means* central banks have no power on output in the long run. In a weaker statement, it means central banks can only decrease output in the long run, not increase it.  
> **username_3**: Suppose central banks _could_ change output in the long run.  Well then, why is the world so poor still, if most of Latin American and Asian central banks have engaged in decades of irresponsible expansionary monetary policy?   How, in such a scenario, would the effect the transmitted. CBs would lower interest rates and then what? People invest more and that's it? No trade-offs, no relative price changes, no updating of expectations?  
> **username_3**: Lucas, for all his problems and theoretical shortcomings, nailed it in his 1972 paper _Expectations and the Neutrality of Money_.  

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