Many economists maintain that money neutrality is a good approximation for how the economy behaves over long periods of time but that in the short run
monetary-disequilibrium theory applies, such that the nominal
money supply would affect output. One argument is that prices and especially wages are
sticky (because of
menu costs, etc.), and cannot be adjusted immediately to an unexpected change in the money supply. An alternative explanation for real economic effects of money supply changes is not that people
cannot change prices but that they do not realize that it is in their interest to do so. The
bounded rationality approach suggests that small contractions in the money supply are not taken into account when individuals sell their houses or look for work, and that they will therefore spend longer
searching for a completed contract than without the monetary contraction. Furthermore, the
floor on nominal wages changes imposed by most companies is observed to be zero: an arbitrary number by the theory of monetary neutrality but a
psychological threshold due to
money illusion. Neutrality of money has been a central question for
monetarism. The most important answers were elaborated within the framework of the
Phillips curve.
Milton Friedman, assuming
adaptive expectations, distinguished a series of short-run Phillips curves and a long-run one, where the short-run curves were supposed to be the conventional, negatively sloped curves, while the long-run curve was actually a vertical line indicating the
natural rate of unemployment. According to Friedman, money was not neutral in the short run, because economic agents, confused by the
money illusion, always respond to changes in the money supply. If the
monetary authority chooses to increase the stock of money and, hence, the price level, agents will be never able to distinguish real and nominal changes, so they will regard the increase in nominal wages as real modifications, so labour supply will also be boosted. However, this change is only temporary, since agents will soon realize the actual state of affairs. As the higher wages were accompanied by higher prices, no real changes in income occurred, that is, it was no need to increase the labour supply. In the end, the economy, after this short detour, will return to the starting point, or in other words, to the natural rate of unemployment.
New classical macroeconomics, led by
Robert E. Lucas, also has its own Phillips curve. However, things are far more complicated in these models, since
rational expectations were presumed. For Lucas, the
islands model made up the general framework in which the mechanisms underlying the Phillips curve could be scrutinized. The purpose of the first Lucasian island model (1972) was to establish a framework to support the understanding of the nature of the relationship between inflation and real economic performance by assuming that this relation offers no trade-off exploitable by economic policy. Lucas' intention was to prove that the Phillips curve
exists without existing. It has been a heritage that there is a trade-off between inflation and unemployment or real economic performance, so it is undoubted that there is a short run Phillips curve (or there are short run Phillips curves). Although there are fewer possible actions available for the
monetary policy to conceit people in order to increase the labour supply, unexpected changes can always trigger real changes. But what is the ultimate purpose of the central bank when changing the money supply? For example, and mostly: exerting countercyclical control. Doing so, monetary policy would increase the money supply in order to eliminate the negative effects of an unfavourable macroeconomic shock. However, monetary policy is not able to utilize the trade-off between inflation and real economic performance, because there is no information available in advance about the shocks to eliminate. Under these conditions, the central bank is unable to plan a course of action, that is, a countercyclical monetary policy. Rational agents can be conceited only by unexpected changes, so a well-known economic policy is completely in vain. However, and this is the point, the central bank cannot outline unforeseeable interventions in advance, because it has no informational advantage over the agents.
The central bank has no information about what to eliminiate through countercyclical actions. The trade-off between inflation and unemployment exists, but it cannot be utilized by the monetary policy for countercyclical purposes. The
New Keynesian research program in particular emphasizes models in which money is not neutral in the short run, and therefore
monetary policy can affect the real economy.
Post-Keynesian economics and
monetary circuit theory reject the neutrality of money, instead emphasizing the role that bank lending and
credit play in the creation of
bank money. Post-Keynesians also emphasize the role that
nominal debt plays: since the nominal amount of debt is not in general linked to inflation, inflation erodes the real value of nominal debt, and deflation increases it, causing real economic effects, as in
debt-deflation. The
Austrian school of economics also rejects the theory of the neutrality of money, arguing that the money newly created by Central Banks (through the
Open market operation system), or by primary banks (through
Fractional-reserve banking system), is always given first to some specific branches of the economy, as in the construction segment, or agriculture, causing those segments that first receive money not to be affected by the price inflation (as the Austrian school also claims that printed and effectively distributed money (M1) causes price inflation). ==Reasons for departure from superneutrality==