Neutrality and Non Neutrality of Money
Neutrality and Non Neutrality of Money 1. Neutrality of Money Neutrality of money means that money is neutral in its effect on the fiscal system. A variation in the money stock can have short-run forces on the level of actual productivity, employment, rate of interest or the composition of final productivity. The only lasting impact of a variation in the money stock is to modify the normal price level. Otherwise, money is neutral if it does not influence corresponding prices and leaves the interest rate untouched. All prices shift proportionally equal. If this occurs without a time lag, the neutrality of money is instantaneous. If there is a time lag, there is long run neutrality. These are variations in absolute prices but individual fiscal units are unresponsive to them. The volume of money ascertains the only absolute prices and their level do not affect the level of earnings, interest, rate of capital formation and employment. It is in this sense that money is neutral in its effects on the working of economy. In the classical system, money is neutral in its effect on the fiscal system. It plays no role in the ascertainment of employment, earnings and productivity. Somewhat they are ascertained by labour, capital stock, state of technology, accessibility of natural resources, saving habits of the inhabitants and so on. 2. Non-Neutrality of Money In the Keynesian system so long as there is redundancy variations in the money supply create permanent non-neutral effects on the rate of interest, the level of employment, earnings and productivity, the rate of capital formation and so on. The post Keynesians, Friedman, Burner and Metzler have shown that money is non-neutral in the short run. As per Friedman “interest rates can’t be used as a guide to monetary policy and that acceleration in the growth rate of money supply produces not lower interest rates but higher ones, if the whole cycle of events is considered. Thus monetary policy cannot peg