The Term “Neutral Money” Gained Recognition in the English Language Literature through Hayek’s Publications

The neutrality of money means the lack of effects of monetary phenomena on real variables.³ There are a few different notions of neutrality of money, depending on how one defines “monetary phenomena.” Probably the most important notion, which we call “dynamic neutrality,” implies that changes in the supply of money only affect nominal variables, while real variables, such as relative prices, production, or employment, remain unaffected. Conversely, the non-neutrality of money means changes in the money supply have an impact on real phenomena.

The concept of neutrality of money is a central economic issue widely discussed from the very beginning of economics as a science. It is sufficient to mention the quantity theory of money formulated at first by Locke, which basically states that the level of prices is always in proportion to the quantity of money. It was probably formulated and believed by classical economists as a reaction against mercantilists’ inflationism, but that reaction was exaggerated and hampered the genuine development of monetary economics. The quantity theory of money is true but only from the point of view of comparative statics. One economy with twice the money supply of another but with no other differences should have twice as high a general price level. However, it does not follow that doubling the money supply only leads to doubling all prices. For the neutrality of money to hold from the dynamic perspective, several conditions must be fulfilled.⁵

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³ The term “neutral money” gained recognition in the English language literature through Hayek’s publications. However, it was in use earlier among Continental economists.

⁵ According to Hayek (2008a [1935]), there are three conditions for the neutrality of money: constant total money stream, perfectly flexible prices, and long-term contracts based on a correct anticipation of future price movements.

—Arkadiusz Sieroń, “Hayek and Mises on Neutrality of Money: Implications for Monetary Policy,” in Banking and Monetary Policy from the Perspective of Austrian Economics, ed. Annette Godart-van der Kroon and Patrik Vonlanthen (Cham, CH: Springer International Publishing, 2018), 154.