Discussion Paper Series 2004-E-18

Long-Run Monetary Neutrality and Contemporary Policy Analysis

Bennett T. McCallum

Arguments are developed concerning a number of topics including long-run monetary neutrality, superneutrality, the natural-rate hypothesis, the quantity theory of money, the equation of exchange, the Fisher equation, and purchasing power parity. These are basic, fundamental topics that all students of monetary economics refer to frequently, but there is evidently considerable disagreement concerning their exact nature. Some of the disagreement has likely been generated by the recent practice by monetary economists of conducting monetary policy analysis in models that include no mention of any monetary variable such as M1 or the monetary base-thereby reflecting the actual policy practice of most central banks. It is argued that these models are consistent in most important ways with highly traditional monetary analysis. More generally, relationships among the various topics are developed and the validity of empirical tests (e.g., cointegration tests) relating to several of the topics are reconsidered.

Keywords: Superneutrality, Natural-rate hypothesis, Quantity theory of money, Cointegration

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

Copyright © 2004 Bank of Japan All Rights Reserved.

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