Neutrality of Money

"Many economists maintain that money neutrality is a good approximation for how the economy behaves over long periods of time but that in the short run monetary-disequilibrium theory applies, such that money would affect output."

Neutrality of money is the idea that a change in the stock of money affects only nominal variables in the economy such as prices, wages and exchange rates but no effect on real (inflation-adjusted) variables, like employment, real GDP, and real consumption.

It is an important idea in classical economics and is related to the classical dichotomy. Money neutrality holds that the central bank does not affect the real economy (e.g., the number of jobs, the size of real GDP, the amount of real investment) by printing money. Any increase in the supply of money would be offset by an equal rise in prices and wages.

Superneutrality of money is a stronger property than neutrality of money. It holds that not only that the economy is neutral as to the level of the money supply but also that the rate of money supply growth has no effect on real variables.

In this case, both the money supply and its growth rate can affect nominal variables such as the price level and inflation rate in the short run.

Purchasing Power

"If money income stays the same, but the price level increases, the purchasing power of that income falls. Inflation does not always imply falling purchasing power of one's real income, since one's money income may rise faster than inflation."

Purchasing power is the number of goods/services that can be purchased with a unit of currency. For example, if you had taken one dollar to a store in the 1950s, you would have been able to buy a greater number of items than you would today, indicating that you would have had a greater purchasing power in the 1950s.

Currency can be either a commodity money, like gold or silver, or fiat currency like US dollars. As Adam Smith noted, having money gives one the ability to "command" others' labor, so purchasing power to some extent is power over other people, to the extent that they are willing to trade their labor or goods for money or currency.

For a price index, its value in the base year is usually normalized to a value of 100. The purchasing power of a unit of currency, say a dollar, in a given year, expressed in dollars of the base year, is 100/P, where P is the price index in that year. So, by definition the purchasing power of a dollar decreases as the price level rises.

Nominal Value

"Nominal values are related to prices and quantities (P and Q) and to real values by the following definitions: nominal value = P•Q = P•real value.
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Nominal value refers to any price or value expressed in money of the day, as opposed to real value, which adjusts for the effect of inflation. Examples include a bundle of commodities, such as gross domestic product, and income.

For a series of nominal values in successive years, different values could be because of differences in the price level, an index of prices. But nominal values do not specify how much of the difference is from changes in the price level.

Real values remove this ambiguity. Real values convert the nominal values as if prices were constant in each year of the series. Any differences in real values are then attributed to differences in quantities of the bundle or differences in the amount of goods that the money incomes could buy in each year.

Thus, the real values index the quantities of the commodity bundle or the purchasing power of the money incomes for each year in the series. The nominal/real value distinction can apply not only to time-series data, as above, but to cross-section data varying by region or householder characteristics.

The Velocity of Money

"In the equation of exchange, velocity of money is one of the key variables determining inflation."

The velocity of money is the average frequency with which a unit of money is spent in a specific period of time. Velocity associates the amount of economic activity associated with a given money supply. When the period is understood, the velocity may be present as a pure number; otherwise it should be given as a pure number over time.