The concept of
Wallace neutrality was first introduced by
Neil Wallace (Wallace (1981)). However the irrelevance proposition proved by Wallace is restricted to a simple environment, leaving the question open of how broad the class of environments is in which the conclusion holds. A series of similar results, under different environments, were obtained in the 1980s. However, these results remain in contexts where money is not dominated as a rate of return. Sargent and Smith (1987) studied an environment and a structure of restrictions on trades in which government-issued currency is dominated as a rate of return and do conclude that open market operations are irrelevant. Early analysis is often supposed to be of little practical relevance for actual
monetary policy because money being dominated as a rate of return by
short-term Treasury securities is routinely observed, which invalidates Wallace's result. However, as noted in Eggertsson and Woodford (2003), in the case of
open-market operations that are conducted at
the zero bound, the
liquidity services provided by money balances at the margin have fallen to zero, so that an analysis of the kind proposed by Wallace is still correct. They also applied the Wallace irrelevance proposition to government purchases of long term debt in a representative-household model. Cúrdia and Woodford (2011)
open market operations powerfully influence economic outcomes due to the introduction of a financial sector engaging in
liquidity transformation. In
Stefan Homburg's (2015) superneutrality article,
open market operations leave real variables unaffected but influence nominal variables in a non-trivial fashion. In a recent paper, Wei Cui and Vincent Sterk (2018) showed that Wallace neutrality does not hold in HANK models with assets with different degrees of liquidity, as the marginal propensity to consume out of liquid wealth is way larger than the marginal propensity to consume out of illiquid wealth. ==See also==