Monetary neutrality is an economic theory that suggests changes in the money supply only affect nominal variables, such as prices and wages, and do not influence real variables, like output and employment, in the long run. In simpler terms, it implies that an increase in the money supply will lead to a proportional increase in price levels, thereby leaving real economic activity unchanged. This notion is often expressed through the equation of exchange, , where is the money supply, is the velocity of money, is the price level, and is real output. The concept assumes that while money can affect the economy in the short term, in the long run, its effects dissipate, making monetary policy ineffective for influencing real economic growth. Understanding monetary neutrality is crucial for policymakers, as it emphasizes the importance of focusing on long-term growth strategies rather than relying solely on monetary interventions.
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