• MONETARY NEUTRALITY
• Changes in the MONEY SUPPLY have no effect on real economic variables such as OUTPUT, real INTEREST rates and UNEMPLOYMENT. If the CENTRAL BANK doubles the money supply, the PRICE level will double too. Twice as many dollars means half as much bang for the buck. This theory, a core belief of CLASSICAL ECONOMICS, was first put forward in the 18th century by David Hume. He set out the classical dichotomy that economic variables come in two varieties, nominal and real, and that the things that influence nominal variables do not necessarily affect the real economy. Today few economists think that pure monetary neutrality exists in the real world, at least in the short run. Inflation does affect the real economy because, for instance, there may be STICKY PRICES or MONEY ILLUSION.
• MONETARY POLICY
• What a CENTRAL BANK does to control the MONEY SUPPLY, and thereby manage DEMAND. Monetary policy involves OPEN-MARKET OPERATIONS, RESERVE REQUIREMENTS and changing the short-term rate of INTEREST (the DISCOUNT RATE). It is one of the two main tools of MACROECONOMIC POLICY, the side-kick of FISCAL POLICY, and is easier said than done well. (See MONETARISM.)
• MONEY
• Makes the world go round and comes in many forms, from shells and beads to GOLD coins to plastic or paper. It is better than BARTER in enabling an economy’s scarce resources to be allocated efficiently. Money has three main qualities:
• • as a medium of exchange, buyers can give it to sellers to pay for goods and services;
• • as a unit of account, it can be used to add up apples and oranges in some common value;
• • as a store of value, it can be used to transfer purchasing power into the future.
• A farmer who exchanges fruit for money can spend that money in the future; if he holds on to his fruit it might rot and no longer be useful for paying for something. INFLATION undermines the usefulness of money as a store of value, in particular, and also as a unit of account for comparing values at different points in time. HYPER-INFLATION may destroy confidence in a particular form of money even as a medium of exchange. Measures of LIQUIDITY describe how easily an ASSET can be exchanged for money (the easier this is, the more liquid is the asset).
• MONEY ILLUSION
• When people are misled by INFLATION into thinking that they are getting richer, when in fact the value of MONEY is declining. Whether, and how much, people are fooled by inflation is much debated by economists. Money illusion, a phrase coined by KEYNES, is used by some economists to argue that a small amount of inflation may not be a bad thing and could even be beneficial, helping to “grease the wheels” of the economy. Because of money illusion, workers like to see their nominal WAGES rise, giving them the illusion that their circumstances are improving, even though in real (inflation-adjusted) terms they may be no better off. During periods of high inflation double-digit pay rises (as well as, say, big increases in the value of their homes) can make people feel richer even if they are not really better off. When inflation is low, GROWTH in real incomes may hardly register.
• MONEY MARKETS
• Any market where MONEY and other liquid ASSETS (such as TREASURY BILLS) can be lent and borrowed for between a few hours and a few months. Contrast with CAPITAL MARKETS, where longer-term CAPITAL changes hands.
• MONEY SUPPLY
• The amount of MONEY available in an economy. In the heyday of MONETARISM in the early 1980s, economists pounced upon the monthly (in some countries, even weekly) MONEY-SUPPLY numbers for clues about future INFLATION. CENTRAL BANKS aim to manage DEMAND by controlling the SUPPLY of money through OPEN-MARKET OPERATIONS, RESERVE REQUIREMENTS and changing the rate of INTEREST (to be exact, the DISCOUNT RATE).
• One difficulty for policymakers lies in how to measure the relevant money supply. There are several different methods, reflecting the different LIQUIDITY of various sorts of MONEY. Notes and coins are completely liquid; some BANK deposits cannot be withdrawn until after a waiting period. M3 (M4 in the UK) is known as broad money, and consists of cash, current account deposits in banks and other financial institutions, SAVINGS deposits and time-restricted deposits. M1 is known as narrow money, and consists mainly of cash in circulation and current account deposits. M0 (in the UK) is the most liquid measure, including only cash in circulation, cash in banks’ tills and banks’ operational deposits held at the Bank of England.
• Although it is a poor predictor of inflation, monetary growth can be a handy LEADING INDICATOR of economic activity. In many countries, there is a clear link between the growth of the real broad-money supply and that of real GDP.
• MONOPOLISTIC COMPETITION
• Somewhere between PERFECT COMPETITION and MONOPOLY, also known as imperfect competition. It describes many real-world markets. Perfectly competitive markets are extremely rare, and few FIRMS enjoy a pure monopoly; OLIGOPOLY is more common. In monopolistic competition, there are fewer firms than in a perfectly competitive market and each can differentiate its products from the rest somewhat, perhaps by ADVERTISING or through small differences in design. These small differences form BARRIERS TO ENTRY. As a result, firms can earn some excess profits, although not as much as a pure monopoly, without a new entrant being able to reduce PRICES through COMPETITION. Prices are higher and OUTPUT lower than under perfect competition.
• MONOPOLY
• When the production of a good or service with no close substitutes is carried out by a single firm with the MARKET POWER to decide the PRICE of its OUTPUT. Contrast with PERFECT COMPETITION, in which no single firm can affect the price of what it produces. Typically, a monopoly will produce less, at a higher price, than would be the case for the entire market under perfect competition. It decides its price by calculating the quantity of output at which its MARGINAL revenue would equal its marginal cost, and then sets whatever price would enable it to sell exactly that quantity.
• In practice, few monopolies are absolute, and their power to set prices or limit SUPPLY is constrained by some actual or potential near-competitors (see MONOPOLISTIC COMPETITION). An extreme case of this occurs when a single firm dominates a market but has no pricing power because it is in a CONTESTABLE MARKET; that is if it does not operate efficiently, a more efficient rival firm will take its entire market away. ANTITRUST policy can curb monopoly power by encouraging COMPETITION or, when there is a NATURAL MONOPOLY and thus competition would be inefficient, through REGULATION of prices. Furthermore, the mere possibility of ¬antitrust action may encourage a monopoly to self-regulate its behaviour, simply to avoid the trouble an investigation would bring.
• MONOPSONY
• A market dominated by a single buyer. A monopsonist has the MARKET POWER to set the PRICE of whatever it is buying (from raw materials to LABOUR). Under PERFECT COMPETITION, by contrast, no individual buyer is big enough to affect the market price of anything.
• MORAL HAZARD
• One of two main sorts of MARKET FAILURE often associated with the provision of INSURANCE. The other is ADVERSE SELECTION. Moral hazard means that people with insurance may take greater risks than they would do without it because they know they are protected, so the insurer may get more claims than it bargained for. (See also DEPOSIT INSURANCE, LENDER OF LAST RESORT, IMF and WORLD BANK.)