A theorem on policy neutrality

Abstract

This paper offers a general condition which resolves the debate over the neutrality of systematic monetary policy in linear macroeconomic models with non-equilibrium prices and rational expectations, as expressed in papers by Gordon, 1976 , Gordon, 1977 , Modigliani (1977) , Fischer (1977) , Phelps and Taylor (1977) , Fethke and Policano, 1979 , Fethke and Policano, 1981 , McCallum, 1977 , McCallum, 1978 , McCallum, 1979a , McCallum, 1979b , McCallum, 1980 and Green and Honkapohja (1983) . The policy neutrality theorem states that a non-equilibrium price function will preserve the neutrality of monetary feedback with respect to exchange in a representative macroeconomic model if and only if the difference between the conditionally expected values of the equilibrium and non-equilibrium prices is independent of monetary feedback in each period. The policy neutrality results of McCallum, 1977 , McCallum, 1978 , McCallum, 1979b and the policy effectiveness results of Fischer (1977) , Phelps and Taylor (1977) , Fethke and Policano, 1979 , Fethke and Policano, 1981 are analyzed in terms of the theorem.