Primer: Coin Neutrality

Note: This article is an excerpt from "Abolish Money (From Economics)! "(chapter 5). The mass is available at online bookstores.

Big errors showtime from smaller ones. In economics, the plausible concepts of coin neutrality too the velocity of coin receive got led to many problems. This attempt defines these concepts; I hash out the difficulties amongst them inwards later on sections.

Money Neutrality

The see of coin neutrality is simple: monetary values are a unit of measurement of measuring for marketplace transactions, too that if nosotros alter the units of measurement, it does non demeanour on the existent value of transactions.

There is a elementary real-world experiment that appears to validate this idea: currency redenomination. For example, General Charles de Gaulle of French Republic created the nouveau franc on Jan 1, 1960, past times hitting the final 2 digits off calculations of existing French francs inwards circulation.*  In other words, a nouveau franc is simply 100 former francs, too contracts were adjusted to compensate. The objective was to render nominal prices dorsum to what experience similar “normal” levels after inflation.

It is clear that simply multiplying all monetary values past times some constant is non going to brand people amend off – other than the convenience value of returning prices to levels that people see to survive “normal.” Within an economical model, the implication is that if nosotros scale monetary values past times some constant, the model dynamics for existent variables should non survive changed. That is, the model output is neutral amongst observe to the monetary unit.

Formally defining coin neutrality is hard (outside of a currency redenomination). This is discussed farther inwards “The Incoherence of Money Neutrality” (Section 11). For the present, I volition stick amongst a hand-waving definition: changing the stock of coin (in a real-world economy, or inwards an economical model) volition non demeanour on existent variables. (Although this is unopen to the definitions commonly used, the previously referenced attempt explains why this Definition is problematic.)

The concept is quite oft broken downwards into long-run too short-run neutrality. Models such every bit Real Business Cycle models  have the belongings that changes inwards coin receive got no outcome on existent variables at whatever time, which is the Definition of short-run neutrality (money is neutral, fifty-fifty inwards the brusque run). However, it is unclear whether Real Business Cycles are anything other than an elaborate practical joke.

Long-run coin neutrality is to a greater extent than commonly encountered. The declaration is that operations that alter the coin stock may receive got a short-term outcome on existent economical variables, but inwards the long term, the alone outcome on changes inwards monetary aggregates is via changes inwards the cost level.

Velocity of Money

Money velocity is a concept that has caused considerable grief. Although nosotros tin mail away ever calculate the “velocity of money,” it is unclear whether it is useful inwards practice. If velocity were constant, the classical Quantity Theory of Money would result.

Within the history of monetary economics, the equation

M∙V = P∙Q

is of utmost importance. Within the equation, m stands for the coin supply, V for the velocity of money, P for the cost level, too Q for the quantity of output. The quantity P∙Q is the dollar value of output (price times quantity), or nominal GDP. The intuition is that the velocity is the seat out of times the coin furnish circulates inwards a year.

If velocity were constant, nosotros could purpose this equation to prepare potent conclusions virtually the human relationship betwixt the coin furnish too nominal gross domestic product (and the cost level). Doubling the coin furnish would double nominal GDP.

Furthermore, if nosotros convey that coin neutrality is at to the lowest degree roughly correct, nosotros would facial expression existent output (Q) to survive largely unaffected past times the doubling of the coin supply. In which case, the implication of a constant velocity is that the cost grade (P) would (at to the lowest degree roughly) double. This matches the simpler definitions of the Quantity Theory of Money.

Of course, if nosotros complaint the difficulties associated amongst exogenous coin previously noted, the value of this insight is express – how just is the coin furnish going to double?

In whatever event, empirical analysis shows us that velocity is nowhere nigh constant. This empirical analysis is pursued at greater length inwards “Instability of Money Velocity.” [Which appears every bit some other department of the book. This online article looks at some coin data, too the instability of the velocity of money.]

Concluding Remarks

Money neutrality too the velocity of coin appear to survive reasonable concepts. The difficulty is attempting to apply them to the existent world.

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Footnote:

* Milton Friedman, on page 21 of Money Mischief: Episodes inwards Monetary History. Published past times Harcourt Brace Jovanovich, 1992.

(c) Brian Romanchuk 2017