Academic journal article Atlantic Economic Journal

Money Is Relevant: A Study of 20 OECD Countries

Academic journal article Atlantic Economic Journal

Money Is Relevant: A Study of 20 OECD Countries

Article excerpt

Money is Relevant: A Study of 20 OECD Countries

Whether money affects price, nominal income, and real income has been studied extensively. While most economists agree that money affects the price level and nominal income, the relationship between money and real income remains controversial. For instance, Keynes [A Treatise on Money, 1930], Davidson [JPKE, 1978], Harrod [Money, 1969], Weintraub [EJ, 1957; IER, 1960] and others maintain that money does matter. On the other hand, Lothian [AER, 1985] and Dwyer and Hafer [St. Louis Review, 1988] have supported the classical neutrality proposition and found that money does not affect real income. An examination of their works indicates that the sample period may be too short or the functional form chosen a priori may be inappropriate.

According to the strong version of the quantity theory of money, the neutrality hypothesis indicates that there is a one-for-one link between money and price and that money does not affect real income if velocity remains unchanged. Note, however, that velocity has varied and reversed its long-term rising trend in recent years. Another explanation is that the LM curve may be horizontal, caused by a liquidity trap, or that the IS curve may be vertical because expenditures are not responsive to changes in the interest rate. Hence, an increase in the money supply would not increase real income. …

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