Book Excerpt: The Incoherence Of Coin Neutrality

Money neutrality is a concept that has attracted tilt inward post-Keynesian economics, but it seems to hold upwards a non-interesting topic. I truly run across real picayune practical divergence betwixt the Monetarist seat – the bête noir of post-Keynesian economic science – as well as a touchstone post-Keynesian sentiment (the thought of a stock-flow norm), in 1 lawsuit nosotros convey that coin is endogenous. Money neutrality is alone a source of debate if the 2 disputants are on the reverse sides of the exogenous-endogenous coin debate. (I hash out that debate inward the seek out – “Primer: Endogenous Versus Exogenous Money” (link to draft on web). An declaration nigh coin neutrality is a waste product of time, equally nosotros necessitate to focus on the truthful underlying number (money endogeneity).

This article is an excerpt from A description of the contents of the majority is constitute here. 

How (Not?) to Define Money Neutrality

The occupation amongst coin neutrality is how it is defined. The intuitive version is that if the coin provide increases as well as all else is held equal, as well as so all that happens is that prices increment proportionally to the modify inward money, as well as “real values” (quantities of output, hours worked, etc.) are unchanged.
The occupation amongst this touchstone “all else equal” (ceteris paribus for people who wish to audio sophisticated) phrasing is hand-waving. We necessitate a to a greater extent than formal definition earlier nosotros hash out the idea; equally otherwise, nosotros terminate upwards debating our ain personal definitions of what that phrasing means.

I grabbed the text Monetary Economics: Theory as well as Policy past times Bennett T. McCallum[16] off my bookshelf, as well as looked upwards the definition of coin neutrality.

Within Section 5.6, he discusses what he refers to equally the “Classical Model.” Money neutrality is defined inward 2 parts (on page 95).

• “The other experiment that nosotros consider at introduce is that of an exogenous, policy-induced increment inward the stock of coin from M0 to M1.” [Note: should hold upwards superscripts; could non easily larn that formatted properly here...]
• “In the novel equilibrium, then, the values of y,r,n, W/P, as well as M/P are the same equally earlier the increment inward M. It follows that the values of P [the cost level] as well as W [wages] must receive got risen inward proportion to M, for otherwise either W/P or M/P would receive got changed. In short, the increment inward the coin stock changes all nominal variables inward the same proportion as well as results inward no modify inward whatever of the existent variables. This holding of the organisation is referred to equally coin neutrality. In the classic model, inward other words, nosotros receive got a instance of the neutrality of money [emphasis inward the original].”

Some mightiness combat the to a higher house phrasing is simply a long-winded way of writing out “increase the coin supply, holding all else equal.” Not so; the key is that nosotros necessitate to specify how the coin provide changes inward the offset place.

Furthermore, the model discussed did non receive got a well-defined concept of time. We tin extend the definition of coin neutrality to short-run as well as long-run neutrality.

• If money is neutral inward the curt run, the mathematical relationships described to a higher house volition concur over all fourth dimension periods (no affair how short).
• If money is neutral inward the long run, the to a higher house mathematical relationships may non concur over curt periods of time, but the fourth dimension serial tend to converge to the predicted values.

I retrieve it would hold upwards rubber to say that almost nobody believes that coin is neutral inward the curt term (as that would imply that velocity is constant, which is evidently incorrect to anyone amongst access to fourth dimension serial data). However, the declaration of Monetarists was that coin was neutral inward the long run.

What makes this definition useless when talking nigh real-world economies is that it assumes that “money” is exogenous; it is an external variable laid at an arbitrary degree past times policy makers. This definition is meaningless inward a model where the coin provide is endogenous. We necessitate to detect another definition, which ends upwards having of import practical differences.

I receive got seen a lot of post-Keynesians object to the notion of long-run coin neutrality, presumably because that is what the Monetarists believed. However, entering into that declaration based on this definition requires accepting that coin is exogenous – which runs counter to post-Keynesian doctrine. Since this definition does non apply to real-world economies, it makes no feel to combat whether it is truthful or not.

Neutral Endogenous Money?

I am unaware of whatever endeavour to define coin neutrality when the coin provide is endogenous. However, it is clear that it is real hard to exercise so.

Since the degree of coin is determined past times the model as well as the exogenous variables, nosotros are inward a seat that nosotros cannot concur “all else equal”: nosotros must modify an exogenous variable inward lodge to modify the coin stock inside the model economy.

We could endeavour to utilization the next definition.

(Failed Definition) Fix 2 scenarios that are defined past times 2 differing sets of exogenous variables. Money is neutral if the existent variables inside the economic scheme ever converge to the same levels, spell the degree of coin tin hold upwards dissimilar inward the 2 scenarios.

This definition fails because it is rather obvious that nosotros tin detect scenarios inward which existent variables volition evidently converge towards dissimilar levels. Examples:

• If 1 scenario were that the province involved launches a nuclear state of war that annihilates all life on Earth, 1 mightiness hold off that economical output would hold upwards somewhat lower than the instance where state of war was avoided.
• If the 2 scenarios involved the regime taxing 20% of gross domestic product versus 90% of gross domestic product (note that taxes are imposed inward existent terms), provide side economists would insist that full output would hold upwards lower inward the high taxation case.

In other words, nosotros cannot let for any possible changes to exogenous variables.

I tin retrieve of 2 reasonable replacements for coin neutrality that appears to capture the intent of the idea.

1. Interest charge per unit of measurement neutrality. Shifting the expected path of the policy charge per unit of measurement past times a fixed amount does non receive got a long-term lawsuit on existent variables.
2. Inflation target neutrality. Assuming that nosotros are inward an inflation-targeting regime, changing the inflation target degree does non receive got a long-term lawsuit on existent variables.

These definitions are presumably closer to what the Monetarists believed, but the changes enhance awkward questions.

In the offset case, why exercise nosotros help nigh monetary policy if it has no existent effects? Do nosotros truly believe that it is impossible for a fundamental banking enterprise to drive a recession past times pursuing a policy of ultra-high involvement rates? Moreover, from the perspective of a mainstream economist, it is hard run across how nosotros tin permanently modify the degree of involvement rates without changing something else. If the fundamental bank’s reaction purpose resembles something similar a Taylor Rule, such a modify would terminate upwards existence equivalent to changing the inflation target (the minute case). [17]

The minute possibility appears to a greater extent than plausible. For example, would nosotros hold off greater long-term Canadian prosperity if the target inflation charge per unit of measurement is 3% instead of 2%? [18]

Even if a pocket-size modify inward the inflation target did matter, nosotros receive got no powerfulness to know what the exact outcome would be, as well as so nosotros terminate upwards amongst presumed “inflation neutrality” because of our ignorance. Of course, at that topographic point are presumably limits – a sustained inflation charge per unit of measurement of 10% mightiness Pb to quite dissimilar economical outcomes than 3%. (The theory existence that at that topographic point is a psychological aversion to “high” rates of inflation, as well as people waste product resources on strategies designed to protect themselves from it.)

Velocity as well as Money Neutrality

One possibility is to limited long-run coin neutrality inward terms of velocity: that is, the velocity of coin tends to revert towards around “equilibrium” or “steady state” value. This seems to hold upwards equivalent to what is wanted for coin neutrality: if 1 scenario results inward having double the coin provide of the other, nominal gross domestic product would besides hold upwards double.

Such remove is predicted past times around Stock-Flow Consistent (SFC) models. The declaration is that economical actors tend to wish to concur fiscal assets nigh target levels that are around multiple of their nominal incomes. (This is known equally a stock-flow norm, equally the desired degree for the stock of fiscal assets is a multiple of the flow of nominal income.) As a result, the ratios of stocks of fiscal property divided past times nominal gross domestic product typically tend towards steady province values. In the instance of money, this ratio is the reciprocal of the velocity of money, as well as thence the velocity converges towards a steady province value.

Since this is simply a restatement of a stock-flow norm, it is unclear why “money neutrality” should hold upwards privileged equally a particular theoretical concept.

Concluding Remarks

Once nosotros convey that the degree of coin balances is determined past times individual sector behaviour, it is nearly impossible to come upwards up amongst a satisfactory definition for coin neutrality. The concept is purely an artifact of the false classical sentiment that the coin provide is exogenous.

Footnotes:

[16]  Bennett T. McCallum, Monetary Economics: Theory as well as Policy, Macmillan Publishing Company, 1989.

[17] Technically, nosotros could shift the involvement charge per unit of measurement generated past times a Taylor Rule past times changing the existent involvement charge per unit of measurement term inside the equation to a dissimilar value from the model’s natural existent charge per unit of measurement of interest. However, the cyberspace termination would hold upwards a persistent missy of the inflation target, as well as so is mathematically equivalent to a modify inward the inflation target spell using the right natural charge per unit of measurement of interest.

[18] Some theories propose that at that topographic point would hold upwards a difference. Mainstream economists are currently excited nigh the lower zilch leap for involvement rates, as well as raising the inflation target would allegedly lower the endangerment of the policy charge per unit of measurement hitting 0%. Alternatively, many post-Keynesians invoke Verdoorn’s Law, which I would summarise as: greater short-term growth increases long-term growth rates, since businesses volition invest more, raising productivity. Although reasonable, it is besides possible that raising the inflation target could simply enhance inflation expectations (and administered prices) without affecting existent variables.

(c) Brian Romanchuk 2017