Monetary Neutrality

According to the theory of monetary neutrality, a change in the stock of money does not affect real variables. Hence real variables like employment, GDP, and consumption does not undergo a change whenever printing of money is increased. But nominal variables do get affected by any change in the stock of money. Thus when money supply increases, it leads to a rise in nominal variables like price and wages. This offsets any change in real variables that may take place due to a rise in the money supply.

However, many economists believe that monetary neutrality does not hold true in several cases. They point towards examples like wages, which are sticky, and debunk the theory that unexpected changes in money supply can affect nominal variables immediately. According to the supernaturality of money, real variables are not only unaffected by changes in the money supply, but also by changes in the money supply growth rate.

Real Variable

Real variables like GDP, employment, and consumption, take into account the factor of inflation. This is unlike nominal variables where the factor of inflation is not accounted for.

Prices

It is also unlikely that prices like menu costs can be immediately adjusted for an increase in the money supply. It has also been suggested that prices are not changed since people are not aware of the need for a change.

Money Supply

Money supply refers to the total supply of money that is in circulation in a nation’s economy. Some economists view the money supply as an important tool to control inflation. They claim when the demand for money is stable, an increase in the money supply may lead to inflation.

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