In which scenario would monetary neutrality not hold?

Monetary neutrality refers to the idea that changes in the money supply do not affect real variables in the long run, such as output and employment, but only impact nominal variables like prices and wages. In the short run, however, prices and wages can be sticky, meaning they do not adjust immediately to changes in monetary policy.

When prices are sticky, an increase in the money supply can lead to changes in real output and employment because prices do not adjust quickly enough to equilibrate supply and demand. This can result in a temporary increase in economic activity as firms respond to increased demand with more production, taking advantage of the unchanged prices. Therefore, in scenarios where prices and wages are rigid, monetary neutrality does not hold.

In the long run, where prices are fully flexible, the economy can adjust to shifts in the money supply without altering real output or employment in a sustainable way. Similarly, low inflation rates and full employment do not necessarily disable monetary neutrality; in these scenarios, adjustments can still occur, illustrating the principle that it is the price stickiness in the short run that causes monetary neutrality to not hold.