Expectations and the Non-Neutrality of Money

Abstract

Money may be non-neutral in a rational expectations framework when (i) there is no possibility of inter-temporal substitution, and (ii) individuals operate over infinite planning lives. It is also pointed out that there might exist a strong correspondence between the existence of a monetary equilibrium and the neutrality of money. Empirical evidence is presented which suggests that in South Africa, broad money might be neutral, while narrow money (M2) might be non-neutral. This should not, however, be interpreted as evidence in favour or against the inherent neutrality or non-neutrality of money, but only as a measure of the success or failure of the monetary authorities. If the broad money supply is by nature endogenous, it might be that the South African Reserve Bank should use M2 and M1 instead in their monetary policy feedback rule. It is shown that a requirement is that the Reserve Bank would have to be independent to implement the optimal feedback rule.