Is the Truism, “Money Is Neutral in the Long Run,” Really True?

Surely, merely running a printing press disgorging fiat money cannot truly increase economic output.  It is a truism.

But what about historic examples of central banks policies and real economic output?

Milton Friedman blamed the Great Depression on tight money.

More recently, the 2008 Great Recession, which by some measures still results in crimped output, was caused by tight money.  Japan’s 20-year deflationary slog has been caused by tight money.

So, by historical example, many macroeconomists seem to agree bad monetary policy can crimp real output for decades at a time and can persist indefinitely, unless corrected, as may be the case today in Japan.

So what is the “long run”? More than 20 years?  And how many years does an individual have to be productive?

Moreover, if an economy is atrophied for 20 years, and then the monetary brakes are finally released, can the economy really regain the lost time or former projected levels of output? Have talented people left for other lands? Have working populations been made cynical? Have innovative industries collapsed and technologies stagnated? Are financiers scarred for another generation, and overly timid?  Have political leaders resorted to warmongering and xenophobia and not nation-building?


Okay, so a central bank can suffocate an economy, and perhaps for decades at a stretch.

But what about growth, the “pushing on a string” problem and all of that?

David Beckworth, of the excellent Macro Musings blog, recently ran this chart:

Yes, between 1940 and 1945, the monetary base more than tripled.

Real output exploded of course, as the U.S. geared up for and entered WWII. From 1940 to1945, real output more than doubled.

In one small example of the surge in real output between 1940 and 1945, more than 2,700 transport “Liberty Ships” were produced in US shipyards, often largely built by women employees.  In 1943, three Liberty ships were produced every day.

The much-touted truism is that “printing money cannot summon real goods and services out of thin air.”

Pray tell, just exactly how did the 2,700 Liberty Ships come to be?

Surely, from nearly nothing, the federal government—armed with its most-potent weapon, the money-printing press—summoned the Liberty Ships into being.  For the enemies of democracy, it was as the war-winning vessels were summoned out of thin air.

And the U.S. economy and technical and industrial base was permanently enlarged by the WWII binge-spending and money-printing.

Money is neutral? Really? In what practical sense is this true?

Modern Context

Of course, if a modern economy is running full-bore, then money-printing may be neutral, merely causing more inflation, and not boosting real output. Indeed, it is possible that excessive money printing could be injurious (not neutral!) by causing too much inflation, upsetting financiers and thus cramping real lending and output.

But in many modern contexts, what we see is developed economies operating at subpar levels for extended stretches, starved not for capital but for demand. And, when certain industries experience more demand than supply at present prices—such as the oil industry from time to time—what we have seen is capital pouring into the gap, and supplies surging.

We have also witnessed rising labor employment participation rates when the demand for labor is strong enough.

In short, demand creates supply.

That “money is neutral” is a difficult proposition in modern, developed economies.


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