The Policy of Neutral Money and its Criticisms



The Policy of Neutral Money and its Criticisms!

Professors Wicksteed, Hayek and Robertson held that the best monetary system is one in which money is neutral. In their opinion, therefore, the monetary authority should aim at the complete neutrality of money.

Money should be a passive factor. It should not be allowed to interfere with the economic forces like productive efficiency, real cost of production and consumer preferences.

The purpose of money is just to facilitate exchange transactions without creating any disturbances in the functioning of economy. Hence, the quantity of money should be so controlled as to result in the total output, total transactions (purchases and sales) and price (or value) of goods and services being exactly what they would be in an efficient barter (moneyless) economy.

The policy of neutral money seeks to do away with the disturbing effects of the changes in the quantity of money on important economic entities such as prices, output, employment and income.

Under the policy of neutral money, the monetary authority has to keep the quantity of money perfectly stable. It should be noted, however, that the perfect stability of money for the neutrality goal implies that the quantity of money is to be kept constant at all times arid in all circumstances, for cyclical fluctuations in an economy are primarily caused by changes in the supply of money.

It has been argued that when a neutral money policy is pursued, there will be business cycles but only comparatively milder adjustments brought about by changes in technology or other factors.


The concepts of neutral money has been severely criticised by many economists as follows:

1. It is based on the outmoded concept of the quantity theory of money:

The critics have, therefore, discarded the concept of neutrality of money as an out-dated concept in the context of modern economy.

2. Neutrality cannot ensure price stability:

A neutral money policy will not ensure stability in the price level, for in a modern economy, technological and scientific developments play a vital role in increasing production and if, under such conditions, quantity of money is kept fixed, it would only lead to deflationary conditions, and hence to a fall in prices.

3. A neutral money policy cannot be followed during depression:

The concept of neutrality of money does not apply to cases of depression when prices are falling even though money supply remains unchanged and the volume of goods and services declines. In a depressionary period, even when the quantity of money is increased in the economy, it cannot revive the price levels.

4. The concept involves contradictions and is also impracticable:

The concept of neutral money and the purpose for which it is aimed at are not only contradictory to each other but impracticable as well. In fact, the concept, being based on the laissez faire philosophy in which perfect competition in a really free economy is assumed, has long been considered obsolete in a modern dynamic economy. Further, to ensure stability in a modern economy, it is essential for the monetary authority to maintain an effective supply of money. Apparently effective monetary control by the central bank and the laissez faire policy can never go together.

In conclusion, it may be affirmed that a neutral money policy cannot check the occurrence of business fluctuations in an economy and that money has come to stay as an active element in a modern economy.