Question

Some economists believe that, in the long run, money is neutral. Explain what is meant by the “neutrality of money.” Identify and discuss the assumptions that lead to the neutrality of money. Critically analyze whether this outcome is consistent with the dual mandate of the Federal Reserve Bank.

Answer 1

neutrality of money says that whatever is the money supply in the economy prices will adjust automatically so that total transaction will be completed in the limited supply of money. mainly this says that quantity of money supply does not matter in the economy. infact qiantity of money supply can not all the real variables in the economy. real variables are affected by real variables only. hence this has an implication that change in the money supply does not matter in the economy.

main assumption that make this possible is that prices adjust instantly, people are in such a perfect information that they are not affected by mere change in prices as prices of all the sectors must adjust simultaneously.

no, this outcome is not consistent with the dual mandate of federal reserve bank. because perfect foresight assumption and instant adjustment of price assumption are not very convencing assumption. infact these assumption are very unrealistic assumptions also. our real worls experiences also says that supply of money does affect the decision of household in shortrun.