Chapter 1: Introduction
The question of what effects money exerts upon economic activity and the price level, together with the magnitude of those effects, remains the central issue in monetary economics. Classical monetary theory suggests that monetary expansion, at a rate exceeding the rate of increase of demand for it, first stimulates output and then, over a considerable time lag of unpredictable duration, lowers output and raises the price level and ensures neutrality of money in the long run (Hume, 1752 ; Marquis, 1996; Appendix 8). Modern monetary economists suggest that prices and wages have rigidities and therefore adjust slowly, conferring ‘transitory’ impact of monetary expansion on output – the non-neutrality theory of money. There is substantial debate whether discretionary monetary expansion to achieve temporary economic gains is a sound strategy. The central hypothesis under investigation is that unanticipated monetary expansions create output fluctuations, inflation uncertainty and, over time, higher unemployment. Modern monetary macroeconomics includes a growing body of literature on monetary theory and policy concerning this and related issues. The following discussion reviews the historical debate and suggests its relevance to the design and conduct of monetary policy in the present context.