Lucas’s way to his monetary theory of large-scale fluctuations

ABSTRACT

This introductory paper offers a look into the intellectual and technical progress that led Robert E. Lucas to his seminal paper entitled Expectations and the neutrality of money. It is argued that the neutrality paper applies the capital-theoretic approach of Lucas’s firm microeconomics of the mid-1960s to the representative agent’s labour supply decision. While emphasizing this similarity, the study gives an overview of the steps through which Lucas changed the basic decision problem of adjusting to price changes from a static Marshallian setting into his neo-Walrasian dynamic stochastic general equilibrium framework. Extensive references to Lucas’s unpublished materials underpin the claims.

KEYWORDS:

• Robert E. Lucas
• choice theory
• monetary neutrality
• rational expectations
• Island model

Acknowledgements

Earlier versions of this paper were presented at the 2021 Winter Institute, and in the April 23, 2021, session of the Philosophy, Politics and Economics Research Seminar series, both organized by the Center for the Study of Economic Liberty, Arizona State University. Helpful comments by Catherine Herfeld, James Forder and Ross B. Emmett are gratefully acknowledged. Special thanks to Max Gillman and my referees for their valuable criticism.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 The paper thus applies methodology in a narrow sense. De Vroey (2016) and Galbács (2020) approach Lucas’s methodology from a more comprehensive perspective.

2 Because of this connection between industry behaviour and firm supply characteristics Lucas (1966/1967a, p. 321) positioned his work into the context of ‘the traditional Marshall-Viner theory of supply’. Reacting to Marshall (1920/2013) and Pigou (1928), Viner (1931) assumed the growth of an industry to take place as the growth in the number of firms. Lucas, by contrast, showed that theoretical description of an industry could be in line with the empirical evidence that industry growth was bolstered by the growth of individual firms (Lucas’s letter to John Helliwell. February 3, 1972. Lucas papers. Box 2. Folder ‘1972’).

3 Phelps was interested in the research at an early stage. In a 1967 letter he asked Lucas to send his and ‘Len’s […] preliminary paper on short run real wage determination’ (Edmund S. Phelps’s letter to Lucas. November 17, 1967. Lucas papers. Box 1. Folder ‘1967’). This detail aids in identifying the date when Lucas and Rapping started the work—which they were uncertain about (Klamer, 1983, p. 35 and 223).

Additional information

Funding

The paper was supported by the János Bolyai Research Scholarship of the Hungarian Academy of Sciences.

Notes on contributors

Peter Galbács

Peter Galbács is a historian of the methodology of post-war business-cycle theory. His recent research concerned how macroeconomics changed during the transmutation from Friedman to Lucas and culminated in a monograph entitled The Friedman-Lucas transition in macroeconomics – A structuralist approach (2020).