Money is non-neutral - notas de clase
Theories of Money: Neutrality vs. Non-Neutrality
I. Monetary Neutrality (The Mainstream View)
Definition of Neutrality: The idea that changes in the quantity of money in circulation do not affect real variables (the actual output and health of the economy).
Real Variables include production (output/GDP), the rate of growth of production, and unemployment.
Money changes only affect nominal variables, such as the aggregate price level (prices).
Mainstream Acceptance: Most macroeconomic models, including Monetarism (Friedman) and New Keynesianism, accept money neutrality, at least in the long run.
Four Propositions Supporting Neutrality (Arguments to Validate the Idea):
Money serves only as a veil: Money is only an intermediate layer to facilitate exchange, and the economy fundamentally acts as if it were a barter economy (exchange of goods and services). Money does not influence real decisions like production or consumption.
Monetary equilibrium holds at all times: There is no excess demand for or supply of money. Individuals will adjust their demand for money (their cash balances) in proportion to changes in the price level.
Quantity Theory of Money (MV = PQ): There is a proportional relationship between the money supply (M) and the aggregate price level (P).
Assuming the velocity of money (V) and the quantity of output (Q) are constant, an increase in M leads only to an increase in P, without affecting Q (real output).
Super-neutrality: Changes in the rate of inflation (the growth rate of the money supply) do not affect real variables.
II. Monetary Non-Neutrality (The Austrian Approach)
Definition of Non-Neutrality: The view that changes in the money supply do have real effects.
Money is not simply a veil and affects relative prices (the ratio of prices between goods and services).
The non-neutrality of money is a central pillar for explaining the business cycle (economic fluctuations) in the Austrian tradition.
Mechanism of Money Creation (Credit Expansion): The supply of money is primarily increased through credit expansion, not literal printing of currency.
Central Banks (like the Federal Reserve) expand credit by:
Buying bonds.
Offering banks and financial institutions loans at lower interest rates (e.g., lowering the Fed funds rate or leader rate), making money cheaper for them.
Banks then offer more attractive rates to clients to place that money, thus expanding credit.
This system is enabled by Fractional Reserve Banking, where banks are only required to hold a fraction of deposits in reserve, lending out the rest.
Austrian Business Cycle Theory (ABCT): Non-neutrality explains economic fluctuations by focusing on the interest rate and the capital structure.
The Central Bank expansion causes the Market Interest Rate to fall below the Natural Rate of Interest (the rate that reflects actual consumer preferences for saving versus consuming).
This artificially low rate distorts individual decision-making.
Entrepreneurs undertake long-term investments (roundabout processes) that appear profitable only at the low rate.
This leads to malinvestment (unsustainable allocation of resources), causing a mismatch between what consumers truly want (based on real savings) and what is being produced. The economy eventually corrects itself, leading to a downturn.
III. Key Sources of Non-Neutrality
Cantillon Effects (Distribution Effects):
New money is not distributed equally.
The people who receive the money first have increased purchasing power.
They spend the money on preferred goods, causing the prices of those specific goods to rise first.
This alters the structure of relative prices and prompts investors to reallocate resources to those goods (leading to malinvestment).
The effect is named after Richard Cantillon, an important predecessor to Adam Smith.
Forced Savings (Hayek):
When the money supply increases and interest rates fall, it encourages capital formation and inflation follows.
The resulting inflation reduces the purchasing power of people with fixed incomes or those who receive the money later.
These people are forced to curb consumption (consume less) and use their existing savings, effectively generating involuntary savings which entrepreneurs then use for investment.
Money Illusion:
People suffer from confusion between real variables and nominal variables.
Individuals fail to understand the difference between a real economic change and a change in the price level (inflation).
This confusion allows monetary policy to affect real behavior and decisions. Standard microeconomic theory generally assumes money illusion does not exist.
Sticky Prices and Long-Term Contracts:
Prices and wages do not adjust immediately to changes in the money supply.
Long-term contracts (e.g., wage agreements) are concluded based on expectations of a future price level.
If actual inflation exceeds expected inflation, the real wage falls, potentially leading to reduced productivity.
Menu costs (the cost of updating prices) can be a factor explaining why prices adjust slowly.
Mundell-Tobin Effect:
Increases in inflation reduce the value of money, leading consumers to hold less money and switch to other assets.
This switch reduces real interest rates, causing real changes in the economy.
IV. Competing and Related Monetary Theories
Keynesianism: Focuses on the non-neutrality of money in the short run.
Keynesians advocate for government public spending (gasto público) and/or lowering interest rates to stimulate aggregate demand.
Keynes famously stressed the importance of the short run, noting: "In the long run we are all dead".
Monetarism (Friedman): Accepts long-run neutrality.
Asserts that inflation is always and everywhere a monetary phenomenon.
Advocated for a Monetary Rule (regla monetaria), suggesting monetary authorities should aim for the money supply to increase roughly at the long-term economic growth rate (e.g., 3-5%).
Modern Monetary Theory (MMT): A contemporary theory, popular with figures like Stephanie Kelton.
MMT posits that as long as there are unemployed real resources (like joblessness or lack of housing), the government should use spending (deficits) to utilize those resources.
The central bank should monetize those deficits (increase the money supply) without worrying about inflation, as the economy will absorb the new money.
New Classical Approach: Heavily challenged the non-neutrality of money.
These models assume instantaneous price adjustment (prices change quickly) and rational expectations (individuals form expectations rationally, do not make systematic mistakes, and do not suffer money illusion).
Some theorists argue that changes in output cause changes in the money supply, reversing the causal direction argued by Austrians and Monetarists.
Inflation and Savings: Inflation is considered one of the worst things a government can do to an economy because it destroys saving (reducing the value and purchasing power of accumulated wealth).
Inflation also has negative distributional effects, often disproportionately harming the poor who cannot easily adjust their asset portfolios.