THENEUTRALI
TYOFMONEYANDFLEXI
BILI
TYOFWAGESAND
A st
apl
eincl
assi
caleconomi
cs,t
heneut
ral
i
tyofmoneysuggest
sthat
changesi
nthesuppl
yofmoneyi
naneconomyonl
yaf
fectnomi
naleconomi
c
v
ari
abl
essuchasexchanger
ates,wages,andt
hepr
icesofgoodsandser
vices.
Accor
ding t
othe t
heor
y,changes i
nthe moneysuppl
ydo notaf
fectr
eal
economi
cvar
iabl
es ofconsumpt
ion,empl
oyment
,and r
ealgr
oss domest
ic
pr
oduct(
GDP)
.Theneut
ral
i
tyofmoneyt
heor
yimpl
i
est
hatt
hecent
ralbankdoes
notaf
fectt
her
eal(
ormaj
or)v
ari
abl
eswi
thi
naneconomy
.Thet
heor
yist
hatany
changei
nthemoneysuppl
yiscount
eract
edbychangesi
nthepr
icesofgoods
andser
vicesandt
hewagest
hatani
ndi
vi
dualear
ns.Realbusi
ness-
cycl
emodel
s
emphasi
zer
ealf
act
ors,
suchast
echnol
ogi
calchanges,
indet
ermi
ningeconomi
c
f
luct
uat
ion,
whi
l
emonet
arybusi
ness-
cycl
emodel
sadv
ocat
ether
oleofmoneyi
n
gener
ati
ngbusi
nesscy
cles.
I
nthel
ate1970s,l
eadi
ngr
epr
esent
ati
vesf
rom maj
orschool
soft
hought
,
suchasTobi
n,Fr
iedmanandLucas,al
lagr
eedt
hatt
her
ateofgr
owt
hoft
he
moneysuppl
yhasr
ealef
fect
sont
heeconomyandpl
aysani
mpor
tantr
olei
nany
ex
planat
ion of out
put f
luct
uat
ions. Ther
e was of cour
se consi
der
abl
e
di
sagr
eementont
henat
ureandst
rengt
hoft
her
elat
ionshi
pbet
weenmoneyand
out
putandont
her
elat
ivepowerofmonet
aryandf
iscalpol
i
cy.Realbusi
ness
cy
clet
heor
ist
ssuppor
tthegener
alpr
edi
cti
onsof‘
real
’asopposedt
o‘monet
ary
’
t
heor
iesoff
luct
uat
ions.Monet
aryneut
ral
i
tyi
sani
mpor
tantpr
oper
tyofr
eal
busi
nesscy
clemodel
s.I
nsuchmodel
sneut
ral
i
tyappl
i
est
otheshor
trunaswel
l
ast
hel
ongr
un.
I
nit
ial
l
yrealbusi
nesscy
clemodel
swer
econst
ruct
edwi
thoutmonet
ary
DA’
sMACROECONOMI
CSPage1
, f
eat
ures.Ky
dlandandPr
escot
t(1982)const
ructamodel
whi
chi
ncl
udedonl
yreal
v
ari
abl
es butwhi
ch coul
dthen be ex
tended t
otake i
nto accountnomi
nal
v
ari
abl
es.Butaf
terbui
l
dingt
hei
rrealmodelt
heyconcl
udedt
hatt
headdi
ti
onofa
monet
arysect
ormaynotbenecessar
ysi
ncebusi
nesscy
clescanbeexpl
ained
al
mostent
ir
elybyr
ealquant
it
ies.Al
thought
heLongandPl
osser(
1983)model
cont
ainsnomonet
arysect
or,
KingandPl
osserexpl
aint
hehi
stor
icalassoci
ati
on
bet
weenmoneyandout
putasr
efl
ect
inganendogenousr
esponseofmoneyt
o
out
put
.Ki
ngandPl
osserr
ejectt
heor
thodoxmonet
ari
sti
nter
pret
ati
onofmoney
-
t
oout
putcausal
i
ty.I
nthei
rmodel
,‘monet
aryser
vicesar
epr
ivat
elypr
oduced
i
nter
medi
ate goods whose quant
it
ies r
ise and f
all wi
th r
eal economi
c
dev
elopment
s’.
Recentt
heor
eti
calef
for
tshav
eat
tempt
edt
opr
ovi
dear
econci
l
iat
ionby
al
l
owi
ngt
echnol
ogyt
obeendogenous.I
nanempi
ri
calmodelt
hataccount
sfor
endogenoust
echnol
ogy
,technol
ogi
calchangesar
est
ati
sti
cal
l
ysi
gni
fi
canti
n
det
ermi
ningf
luct
uat
ionsi
nrealact
ivi
ty.Cr
it
icspoi
ntoutt
hatt
heev
idencedoes
notsuppor
ttheassumpt
ionofneut
ral
i
tyofmoney
.Theyar
guet
hatr
educt
ionsof
money gr
owt
h and i
nfl
ati
on ar
e al
way
s associ
ated wi
th per
iods ofhi
gh
unempl
oyment
.Monet
arypol
i
cyappear
stohav
east
rongi
nfl
uenceont
her
eal
economy
.
RBCt
heor
yassumest
hatwagesandpr
icesar
ecompl
etel
yfl
exi
ble.Ther
e
ar
enomar
keti
mper
fect
ions.I
tist i
he"nv
isi
blehand"t
hatcl
ear
sthemar
ketand
l
eadst
oanopt
imalal
l
ocat
ionofr
esour
cesi
ntheeconomy
.RBC pr
oponent
s
ar
guet
hatt
hedegr
eeofpr
icest
icki
nessoccur
ri
ngi
nther
ealwor
ldi
snotf
or
under
standi
ng economi
cfl
uct
uat
ions.Fl
exi
blepr
icest
o beconsi
stencewi
th
mi
cro economi
ctheor
y.Wages and pr
ice st
icki
ness expl
ains i
nvol
unt
ary
unempl
oymentandnonneut
ral
i
tyofmoney
.
DA’
sMACROECONOMI
CSPage2
TYOFMONEYANDFLEXI
BILI
TYOFWAGESAND
A st
apl
eincl
assi
caleconomi
cs,t
heneut
ral
i
tyofmoneysuggest
sthat
changesi
nthesuppl
yofmoneyi
naneconomyonl
yaf
fectnomi
naleconomi
c
v
ari
abl
essuchasexchanger
ates,wages,andt
hepr
icesofgoodsandser
vices.
Accor
ding t
othe t
heor
y,changes i
nthe moneysuppl
ydo notaf
fectr
eal
economi
cvar
iabl
es ofconsumpt
ion,empl
oyment
,and r
ealgr
oss domest
ic
pr
oduct(
GDP)
.Theneut
ral
i
tyofmoneyt
heor
yimpl
i
est
hatt
hecent
ralbankdoes
notaf
fectt
her
eal(
ormaj
or)v
ari
abl
eswi
thi
naneconomy
.Thet
heor
yist
hatany
changei
nthemoneysuppl
yiscount
eract
edbychangesi
nthepr
icesofgoods
andser
vicesandt
hewagest
hatani
ndi
vi
dualear
ns.Realbusi
ness-
cycl
emodel
s
emphasi
zer
ealf
act
ors,
suchast
echnol
ogi
calchanges,
indet
ermi
ningeconomi
c
f
luct
uat
ion,
whi
l
emonet
arybusi
ness-
cycl
emodel
sadv
ocat
ether
oleofmoneyi
n
gener
ati
ngbusi
nesscy
cles.
I
nthel
ate1970s,l
eadi
ngr
epr
esent
ati
vesf
rom maj
orschool
soft
hought
,
suchasTobi
n,Fr
iedmanandLucas,al
lagr
eedt
hatt
her
ateofgr
owt
hoft
he
moneysuppl
yhasr
ealef
fect
sont
heeconomyandpl
aysani
mpor
tantr
olei
nany
ex
planat
ion of out
put f
luct
uat
ions. Ther
e was of cour
se consi
der
abl
e
di
sagr
eementont
henat
ureandst
rengt
hoft
her
elat
ionshi
pbet
weenmoneyand
out
putandont
her
elat
ivepowerofmonet
aryandf
iscalpol
i
cy.Realbusi
ness
cy
clet
heor
ist
ssuppor
tthegener
alpr
edi
cti
onsof‘
real
’asopposedt
o‘monet
ary
’
t
heor
iesoff
luct
uat
ions.Monet
aryneut
ral
i
tyi
sani
mpor
tantpr
oper
tyofr
eal
busi
nesscy
clemodel
s.I
nsuchmodel
sneut
ral
i
tyappl
i
est
otheshor
trunaswel
l
ast
hel
ongr
un.
I
nit
ial
l
yrealbusi
nesscy
clemodel
swer
econst
ruct
edwi
thoutmonet
ary
DA’
sMACROECONOMI
CSPage1
, f
eat
ures.Ky
dlandandPr
escot
t(1982)const
ructamodel
whi
chi
ncl
udedonl
yreal
v
ari
abl
es butwhi
ch coul
dthen be ex
tended t
otake i
nto accountnomi
nal
v
ari
abl
es.Butaf
terbui
l
dingt
hei
rrealmodelt
heyconcl
udedt
hatt
headdi
ti
onofa
monet
arysect
ormaynotbenecessar
ysi
ncebusi
nesscy
clescanbeexpl
ained
al
mostent
ir
elybyr
ealquant
it
ies.Al
thought
heLongandPl
osser(
1983)model
cont
ainsnomonet
arysect
or,
KingandPl
osserexpl
aint
hehi
stor
icalassoci
ati
on
bet
weenmoneyandout
putasr
efl
ect
inganendogenousr
esponseofmoneyt
o
out
put
.Ki
ngandPl
osserr
ejectt
heor
thodoxmonet
ari
sti
nter
pret
ati
onofmoney
-
t
oout
putcausal
i
ty.I
nthei
rmodel
,‘monet
aryser
vicesar
epr
ivat
elypr
oduced
i
nter
medi
ate goods whose quant
it
ies r
ise and f
all wi
th r
eal economi
c
dev
elopment
s’.
Recentt
heor
eti
calef
for
tshav
eat
tempt
edt
opr
ovi
dear
econci
l
iat
ionby
al
l
owi
ngt
echnol
ogyt
obeendogenous.I
nanempi
ri
calmodelt
hataccount
sfor
endogenoust
echnol
ogy
,technol
ogi
calchangesar
est
ati
sti
cal
l
ysi
gni
fi
canti
n
det
ermi
ningf
luct
uat
ionsi
nrealact
ivi
ty.Cr
it
icspoi
ntoutt
hatt
heev
idencedoes
notsuppor
ttheassumpt
ionofneut
ral
i
tyofmoney
.Theyar
guet
hatr
educt
ionsof
money gr
owt
h and i
nfl
ati
on ar
e al
way
s associ
ated wi
th per
iods ofhi
gh
unempl
oyment
.Monet
arypol
i
cyappear
stohav
east
rongi
nfl
uenceont
her
eal
economy
.
RBCt
heor
yassumest
hatwagesandpr
icesar
ecompl
etel
yfl
exi
ble.Ther
e
ar
enomar
keti
mper
fect
ions.I
tist i
he"nv
isi
blehand"t
hatcl
ear
sthemar
ketand
l
eadst
oanopt
imalal
l
ocat
ionofr
esour
cesi
ntheeconomy
.RBC pr
oponent
s
ar
guet
hatt
hedegr
eeofpr
icest
icki
nessoccur
ri
ngi
nther
ealwor
ldi
snotf
or
under
standi
ng economi
cfl
uct
uat
ions.Fl
exi
blepr
icest
o beconsi
stencewi
th
mi
cro economi
ctheor
y.Wages and pr
ice st
icki
ness expl
ains i
nvol
unt
ary
unempl
oymentandnonneut
ral
i
tyofmoney
.
DA’
sMACROECONOMI
CSPage2
