The Prize Lecture

The Robert Lucas article in Wikipedia includes a link to a Monetary Neutrality PDF, his 1995 Nobel "Prize lecture" (20 pages). Parts of it escape me, but parts are very good.

Lucas opens with an excerpt from David Hume from 1752. "From the beginnings of modern monetary theory," says Lucas.

Hume writes:

money is nothing but the representation of labour and commodities, and serves only as a method of rating or estimating them. Where coin is in greater plenty, as a greater quantity of it is required to represent the same quantity of goods, it can have no effect, either good or bad...

Lucas refers to such changes in money as "just units changes," comparable I suppose to reporting the temperature in Celsius instead of Fahrenheit.

Money, for me, is the central issue of economics. For that matter, misunderstanding money is the original cause of our economic troubles. I accept what Lucas says, and Hume, because it is a reputable idea of long standing, but I accept it tentatively. Money is of central importance. There is no "just" about it.

In 1752 we were near peak in the cycle of civilization and near the beginning of that 150-year "greatest age of the inducement to invest" noted by Keynes in 1936. At that point in the cycle perhaps one might observe that money "serves only as a method for rating or estimating" labor and commodities. Today, money serves also for accumulating and storing value. Stored accumulations of money do not circulate, or circulate only at extra cost. Either way, the consequences are significant.

Lucas offers a second excerpt from David Hume:

Were all the gold in England annihilated at once, and one and twenty shillings substituted in the place of every guinea, would money be more plentiful or interest lower? No surely: We should only use silver instead...

As Friedman said, money is "fungible." Interchangeable.

"These are two of Hume’s statements of what we now call the quantity theory of money," Lucas writes, "the doctrine that changes in the number of units of money in circulation will have proportional effects on all prices that are stated in money terms, and no effect at all on anything real, on how much people work or on the goods they produce or consume."

This, then, is a modern expression of the quantity theory: An increase in the quantity of money has a "proportional" effect on prices, but "no effect at all on anything real."

It is not true, of course. Should incomes and prices all magically double, our debt is suddenly half the burden it was before. That is a real difference.

For some reasaon, I want to attribute the shock-value in this to Krugman.

Lucas continues:

Notice, though, that there is something a little magical about the way that changes in money come about in Hume’s examples. All the gold in England gets “annihilated.” ... Is this just a matter of exposition, or should we be concerned about it! This turns out to be a crucial question.

He again quotes Hume, who says that an increase in the quantity of money "must first quicken the diligence of every individual before it increases the price of labour." In other words, Hume thought that the existing quantity of money, be it lesser or greater, had no bearing on economic conditions, but that a change in the quantity of money had significant consequences.

Again: Hume thought that the existing quantity of money, be it lesser or greater, had no bearing on economic conditions, but that a change in the quantity of money had significant consequences.

Says Lucas:

This tension between two incompatible ideas: that changes in money are neutral units changes, and that they induce movements in employment and production in the same direction, has been at the center of monetary theory at least since Hume wrote.

Lucas fantasizes a "tension" between ideas that are by no means incompatible. "Changes in money are neutral units changes," he writes. But the example of a change in money that Lucas provides is David Hume's "annihilation" of gold.

Hume did not use the annihilation of gold as a change of circumstances. He used annihilation to compare two different sets of circumstances. Circumstances were suddenly, "magically" different to provide two different cases for comparison. Hume knew well that changes in money affect the economy. He was not talking of changes having no effect.

With the annihilation he was comparing two different states or sets of circumstances: a society with gold, and the same society without gold. One set of circumstances, Hume said, is no better or worse than the other as far as economic conditions are concerned. But in neither circumstance is there any change in the money.

This is not the same as saying (for example) that a change from "having gold" to "not having gold" would be insignificant. But those are the words Lucas puts in David Hume's mouth.


In The General Theory, Maynard Keynes quoted Hume:

It is only in this interval or intermediate situation, between the acquisition of money and a rise in prices, that the increasing quantity of gold and silver is favourable to industry.... It is of no manner of consequence, with regard to the domestic happiness of a state, whether money be in a greater or less quantity. The good policy of the magistrate consists only in keeping it, if possible, still increasing; because by that means he keeps alive a spirit of industry in the nation, and increases the state of labour in which consists all real power and riches.

By that standard, one may glance at our trade deficit and conclude that China is the good magistrate today.

Clearly, Hume distinguished between levels of money on the one hand, and changes in those levels on the other. Lucas blurs that distinction.