Lucas and Hume on Monetary Non-neutrality: A Tension between the Logic and the Technique of Economics

Abstract

Economists lost a valid theory of monetary non-neutrality, which relates to how new money enters the economy at different points and in the process changes relative prices. This theory was introduced by David Hume, among others, but it has since disappeared from the leading conversations. The disappearance was not caused by any theoretical or empirical weakness, however. Using Robert Lucas’s Nobel lecture as a case study, I argue that the theory might have disappeared because it did not fit into the popular technical frameworks’ modeling constraints, which view money as inherently neutral and introduce non-neutrality only through external frictions.