Views
Many economists maintain that money neutrality is a good approximation for how the economy behaves over long periods of time but that in the short run monetary-disequilibrium theory applies, such that the nominal money supply would affect output. One argument is that prices and especially wages are sticky (because of menu costs, etc.), and cannot be adjusted immediately to an unexpected change in the money supply. An alternative explanation for real economic effects of money supply changes is not that people cannot change prices but that they do not realize that it is in their interest to do so. The bounded rationality approach suggests that small contractions in the money supply are not taken into account when individuals sell their houses or look for work, and that they will therefore spend longer searching for a completed contract than without the monetary contraction. Furthermore, the floor on nominal wages changes imposed by most companies is observed to be zero: an arbitrary number by the theory of monetary neutrality but a psychological threshold due to money illusion.
The New Keynesian research program in particular emphasizes models in which money is not neutral in the short run, and therefore monetary policy can affect the real economy.
Post-Keynesian economics and monetary circuit theory reject the neutrality of money, instead emphasizing the role that bank lending and credit play in the creation of bank money. Post-Keynesians also emphasize the role that nominal debt plays: since the nominal amount of debt is not in general linked to inflation, inflation erodes the real value of nominal debt, and deflation increases it, causing real economic effects, as in debt-deflation.
Read more about this topic: Neutrality Of Money
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—Marvin Cohen, U.S. author and humorist.
In conversation, after having taken a strong position in an argument and heard a complete refutation of his position.
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—Philip Dormer Stanhope, 4th Earl Chesterfield (1694–1773)