The distinction between ‘Inside Money’ and ‘Outside Money’ was introduced in macro economics by Gurley, and Shaw in their work ‘Money in a theory of Finance’. They made this distinction in order to show that neutrality of money can be ensured with only ‘inside money’ or only with ‘outside money’ but not when both types of money exist in an economy.
Inside money refers to the financial claims of economics units in the private actor of the economy. Outside money is government money. It consists of the liabilities of the government as a debtor. It is, therefore, a claim of the private sector as creditors.If there is only ‘inside money’, any increase in the net wealth of the creditors would be counterbalanced by a corresponding reduction in the net wealth of the debtors. So there would be no change in the net wealth of the community in this case and so money would remain neutral.
If there is only ‘outside money’, an increase of this type of money causes a corresponding increase in the net wealth of the economy of the private sector. This causes rise in the price level, leaving the relative prices unchanged. In this case money is neutral.
The third case is where ”inside money’ and ‘outside money’ both co-exist. Here a change in the stock of money disturbs the neutrality of money because it will cause change in relative prices due to income redistribution between the public sector and the private sector. Additional money supply by the government will change the relative prices of the assets in the private sector through its effect on the rate of interest. Extra money in the private sector invariably affects the portfolios of investors and hence its is non-neutral.
It should be noted that lately the distinction between ‘inside money’ and ‘outside money’ stands blurred because of the increase in the width and the depth of the capital market and deregulation of non-banking financial institutions.