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MONETARYNEUTRALITYPrizeLecture,December7,1995byROBERTE.LUCAS,JR*UniversityofChicago,USAINTRODUCTIONTheworkforwhichIhavereceivedthisprizewaspartofanefforttounder-standhowchangesintheconductofmonetarypolicycaninfluenceinfla-tion,employment,andproduction.Somuchthoughthasbeendevotedtothisquestionandsomuchevidenceisavailablethatonemightreasonablyassumethatithadbeensolvedlongago.Butthisisnotthecase:Ithadnotbeensolvedinthe1970swhenIbeganmyworkonit,andevennowthisquestionhasnotbeengivenanythinglikeafullysatisfactoryanswer.InthislectureIwilltrytoclarifywhatitisabouttheproblemofbringingavailableevidencetobearontheassessmentofdifferentmonetarypoliciesthatmakesitsodifficult,andtoreviewtheprogressthathasbeenmadetowardsolvingitinthelasttwodecades.Fromthebeginningsofmodernmonetarytheory,inDavidHume’smar-velousessaysof1752,OfMoneyandOfInterest,conclusionsabouttheeffectofchangesinmoneyhaveseemedtodependcriticallyonthewayinwhichthechangeiseffected.Informulatingthedoctrinethatwenowcallthequantitytheoryofmoney,Humestressedtheunits-changeaspectofchangesinthemoneystock,andtheirrelevanceofsuchchangestothebehaviorofrationalpeople.“Itisindeedevident,”hewroteinOfMoney,“thatmoneyisnothingbuttherepresentationoflabourandcommodities,andservesonlyasamethodofratingorestimatingthem.Wherecoinisingreaterplenty,asagreaterquantityofitisrequiredtorepresentthesamequantityofgoods,itcanhavenoeffect,eithergoodorbad...anymorethanitwouldmakeanalte-rationonamerchant’sbooks,if,insteadoftheArabianmethodofnotation,whichrequiresfewcharacters,heshouldmakeuseoftheRoman,whichrequiresagreatmany.”(p.28)1Hereturnstothisideathatchangesinthequantityofmoneyarejustunits*IthankNancyStokeyforinvaluablediscussionandcriticism.IamalsoverygratefulforcommentsfromWilliamBrock,JohnCochrane,MiltonFriedman,AnilKashyap,RandallKroszner,CaseyMulligan,SherwinRosen,AllenSanderson,ThomasSargent,JohnTaylor,NeilWallace,WarrenWeber,andJörgenWeibull.1AllpagereferencestoHume’sessaysaretoHume(1970).Ihaveleftthespellingasintheoriginalandmodernizedthepunctuation.RobertE.Lucas,Jr.247changesinOfInterest:“WereallthegoldinEnglandannihilatedatonce,andoneandtwentyshillingssubstitutedintheplaceofeveryguinea,wouldmoneybemoreplentifulorinterestlower?Nosurely:Weshouldonlyusesil-verinsteadofgold.Weregoldrenderedascommonassilver,andsilverascommonascopper,wouldmoneybemoreplentifulorinterestlower?Wemayassuredlygivethesameanswer.Ourshillingswouldthenbeyellow,andourhalfpencewhite,andweshouldhavenoguineas.Nootherdifferencewouldeverbeobserved,noalterationoncommerce,manufactures,naviga-tion,orinterest,unlessweimaginethatthecolorofmoneyisofanycon-sequence.”(p.47)ThesearetwoofHume’sstatementsofwhatwenowcallthequantitythe-oryofmoney:thedoctrinethatchangesinthenumberofunitsofmoneyincirculationwillhaveproportionaleffectsonallpricesthatarestatedinmoneyterms,andnoeffectatallonanythingreal,onhowmuchpeopleworkoronthegoodstheyproduceorconsume.Notice,though,thatthereissomethingalittlemagicalaboutthewaythatchangesinmoneycomeaboutinHume’sexamples.AllthegoldinEnglandgets“annihilated.”Elsewhereheasksusto“supposethat,bymiracle,everymaninGreatBritainshouldhavefivepoundsslippedintohispocketinonenight.”(p.51)Moneychangesinrealitydonotoccurbysuchmeans.Isthisjustamatterofexpo-sition,orshouldwebeconcernedaboutit!Thisturnsouttobeacrucialquestion.Infact,Humewrites:“Whenanyquantityofmoneyisimportedintoanation,itisnotatfirstdispersedintomanyhandsbutisconfinedtothecoffersofafewpersons,whoimmediatelyseektoemployittoadvanta-ge.Hereareasetofmanufacturersormerchants,weshallsuppose,whohavereceivedreturnsofgoldandsilverforgoodswhichtheyhavesenttoCadiz.Theyaretherebyenabledtoemploymoreworkmenthanformerly,whoneverdreamofdemandinghigherwages,butaregladofemploymentfromsuchgoodpaymasters.[Theartisan]...carrieshismoneytothemarket,wherehefindseverythingatthesamepriceasformerly,butreturnswithgreaterquantityandofbetterkindsfortheuseofhisfamily.Thefarmerandgarde-ner,findingthatalltheircommoditiesaretakenoff,applythemselveswithalacritytoraisingmore...Itiseasytotracethemoneyinitsprogressthroughthewholecommonwealth,whereweshallfindthatitmustfirstquickenthediligenceofeveryindividualbeforeitincreasesthepriceoflabour.”(p.38)Symmetrically,Humebelievesthatamonetarycontractioncouldinducedepression.“Thereisalwaysanintervalbeforemattersbeadjustedtotheirnewsituation,andthisintervalisaspernicioustoindustrywhengoldandsil-verarediminishingasitisadvantageouswhenthesemetalsareincreasing.Theworkmanhasnotthesameemploymentfromthemanufacturerormer-chantthoughhepaysthesamepriceforeverythinginthemarket.Thefar-mercannotdisposeofhiscornandcattle,thoughhemustpaythesamerenttohislandlord.Thepoverty,andbeggary,andslothwhichmustensueareeasilyforeseen.”(p.40)Humemakesitclearthathedoesnotviewhisopinionsabouttheinitial248EconomicSciences1995effectsofmonetaryexpansionsasmajorqualificationstothequantitytheory,tohisviewthat“itisofnomannerofconsequence,withregardtothedomes-tichappinessofastate,whethermoneybeinagreaterorlessquantity.”Perhapshesimplydidnotseethattheirrelevanceofunitschange