The Neutrality of Money

Nick Rowe does an immense public good whenever he writes about esoteric monetary concepts in a way that is both accessible, and causes a high level of debate in the comments. At least he does me an immense service that I should probably be paying him for. Thanks for the consumer surplus, Nick!

In a recent post, he lays out an analogy between Daylight Savings Time and the non-neutrality of money (in the short run).

A purely nominal change (whether we say than solar noon is called “12.00″ or “13.00″) will have a big real effect. Even though we all know that it’s just a nominal change. Nobody is fooled by the government changing our watches without us seeing them do it. Nobody suffers from “time illusion”. We know it’s not really earlier. In fact, it’s the people who don’t hear that the time has changed who are likely to still get up at the same real time, by the sun.

And the real effects of this nominal change will last, at least until the Spring, when the government will tell us to change our watches forward again.

Read the whole thing, because it is a very good discussion about how monetary policy can have real effects in the short run. Nick, of course, subscribes to money neutrality in the long run. It is informative to discuss the nature of the short- and long run with regard to economics. When normal people talk about the “long run”, they implicitly mean a time in the future (which is sometimes delineated). This is buttressed by the use of the famous Keynes quote. Of course, this is not really what is meant by “the long run” in economics. The long run in economics is reached when the economy reaches a stable equilibrium after some change. As a very simple thought experiment; assume that all goods and services in the economy are priced in the same manner gasoline is — globally and (mostly) electronically — and thus prices adjust relatively quickly, and assume that markets are perfectly efficient. When the Fed makes a change to the supply of money, all prices adjust within a day or two. That is the long run. The time span doesn’t really matter. Obviously the real world is nothing like that, and there is a time lag between the change and the new equilibrium, but it need not mean “a long time”, although it often does.

Many economic models assume long-run money neutrality (or superneutrality!). That changes in the money supply only affect prices in the long run, and the economy has a long run growth rate that it converges upon given by its capital stock, and that the long-run composition of investment/saving/output is unaffected by the short-run fluctuations.

While I use these types of models for my study of economics, I’m going to make the (maybe controversial) claim that I don’t believe in the neutrality of money, even in the long run. I think that the features of the money system that we use do affect the type of transactions that take place, and the composition of investment/saving/output. Even in the long run.

For example, every advanced society in the world uses a money system that is characterized by money with positive interest rates. This one fact is the reason that people save in money (i.e. have a bank account…you could argue that the setup of our money system is the reason personal banking exists!). If positive interest rates didn’t exist, then people would save in other vehicles. A concrete example of this is negative interest on money — stamp scrip. You can’t hoard money that has negative interest. So how do you save? Well, you invest in real assets that appreciate at a higher rate of interest, compensating you for their illiquid nature. In Worgl, Austria, that was trees. To rid themselves of money, people planted trees. Trees appreciate in value, and so raise the capital stock…and people were doing this in the midst of the Great Contraction of 1929-33. That is a completely different dynamic that, if the system had not been shut down, would have large real effects on the long run path of the Worgl economy. Another popular place where complementary currencies have changed the long-run dynamic is elderly care, which is very expensive, and generally under-supplied by the market (which is why we have old-age insurance and medical care). Fureai Kippu no only allows elderly people to remain in their homes longer, but allows adolescents to partially pay for tuition — solving two social problems at once! More people are cared for and educated than otherwise would be under a single-currency dynamic.

Is the neutrality of money a useful concept? Yes. But I don’t think that it is literally true. Different types of money embody drastically different values, and thus affect what is produced and consumed. The money system we use is characterized by scarcity, and induces competition for money. That is a completely different dynamic than, say, a LETS money system (like Fureai Kippu), where money is issued by the users themselves. Bernard Lietaer, characterizes this distinction as Yin money and Yang money. As he is fond of saying (paraphrased from his book, The Future of Money):

“Currently, our biggest problem with money and currencies is unconsciousness. We are not aware of what we are doing around money. We haven’t really thought about what money does to us. We believe it’s neutral, so it doesn’t matter. But it’s not neutral: it deeply shapes us and our societies. The first thing that has to happen before complementary currency systems can effect real change on a larger scale is a shift in consciousness and awareness.”

I think that is correct, but I’d be interested in hearing what Nick and others have to say about the subject.

PS I suppose the above argument puts me in the “post Keynesian” camp. Although I don’t emphasize the role of debt deflation over that of monetary disequilibrium in producing real effects.