Abstract
This paper evaluates the effect of a change in the quantity of money on relative prices in the U.S. economy based on quarterly time-series for the period of 1959 to 2013. We also estimate the implication of a change in relative prices on the rate of inflation and macroeconomic variables. The empirical results indicate that the change of money supply not only affects relative prices but also affects the inflation rate and real variables, such as investment, natural rate of unemployment and potential GDP, through the change in relative prices. The relevant finding of our study is that money is not neutral in a non-traditional sense because a change in the money supply disturbs relative prices and, consequently, the allocation of resources in the economy. This finding has serious implications that must be considered in the transmission mechanisms of monetary policy.
Highlights
Economists in general agree with the idea that the observed variations in the nominal price are related to changes in the quantity of money
We evaluate the indirect effect of the change in the money supply on the inflation rate and on the real variables through relative price, replacing in Eq (2) the dependent variable (Pi/Pj)t of the Eq (1)
Note that the indirect effect shows that variations in the money supply affect changes in relative prices (Model 3A), which in turn affect the natural rate of unemployment (Model 3B)
Summary
Economists in general agree with the idea that the observed variations in the nominal price are related to changes in the quantity of money. A change in relative prices, resulting from changes in the quantity of money, must be considered when analyzing monetary policy transmission mechanisms because they indirectly affect real economic variables such as investment, natural rate of unemployment and potential output.
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