Monetary Neutrality

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Lucas, “Monetary Neutrality”


• Anticipated changes in monetary growth result in an “inflation tax” that reduces productivity.

• Unanticipated monetary growth can stimulate production. Unanticipated monetary contraction can reduce production.


• Paper addresses the issue of whether changes in the monetary supply are neutral or not.

• Talks about David Hume’s writing. Hume addressed the question of monetary neutrality, bringing up the conflict between the expectation that increased money supply (decreased currency value) should be a perfect substitute vs. the possibility that an increase in the money supply should bring about greater productivity. Leads to the intuition that it matters how money is introduced. (p 248)

• Central prediction of quanitity theory is that in the long run increases in money growth should be neutral.

• Lucas has graphic that shows virtually perfect correlation between money growth and inflation.

• Research has shown that large scale reductions in money growth can be associated with large scale depressions, or no depressions – all depends on how they are carried out. (p. 252) I believe his intent is to say that if the reductions are anticipated, they do not result in a depression.

• Uses a simple mathematical model to show three findings:

o if the monetary increase is given lump sum regardless of labor product, the result is an inflation tax

o if the monetary increase is tied to production, then the result is monetary neutrality

o if the monetary increase occurs in the current period, but knowledge of how much of an increase is delayed to the market participants until some future period, the market participants will increase output as a hedge against uncertainty.

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