The results of changes in money demand and monetary neutrality

Patinkin (1965) used the general equilibrium system to prove: If one assumes that an increase in money demand is accompanied by an increase in the demand for all other goods. and the demand for bonds decreases, then the new equilibrium will be reached when all currency prices fall in the same proportion and interest rates remain unchanged; accordingly, the respective outputs of these products also remain unchanged. However, in Keynesian monetary theory, it is assumed that the growth of money demand is achieved only by the holding of bonds, and this is the meaning of Keynes' liquidity preference theory. This change in liquidity preference is not neutral, but will lead to an increase in interest rates, which will affect investment and other real variables of the economic system.

Similarly, changes in the ratio between internal money and external money caused by changes in the cash deposit ratio and/or bank reserve deposit ratio are not neutral. However, it has been suggested that if the supply function and demand function of the financial sector do not have money illusion, then the growth of external money will not change this ratio, so its effect is neutral.

If the money increase is caused by open market purchases of government bonds (so that, at the outset, total financial assets are unchanged), or if there is a truly balancing effect on commodity markets, as in May As Ziller (1951) pointed out, the equilibrium interest rate will fall so that money will no longer be neutral in its role. However, neutrality can also arise if individuals fully anticipate and discount future taxes on government bonds (in which case bonds are not part of net wealth).