Lucas’s methodological divide in inflation theory: a student’s journey

Abstract

ABSTRACT The paper describes how Robert E. Lucas, Jr.’s monetary economies are based on his methodology of using a single general equilibrium dynamic optimization model with microeconomic foundations that can be tested with econometric methods. It shows how, since his 1972 neutrality paper, Phillips curves continue to be a foundation for policy prescription contrary to Lucas’s 1972 results. In support of Lucas’s hypothesis, historical Phillips curves are shown to be idiosyncratic rather than a basis for policy. Using Lucas’s alternative microfounded approaches to money, growth, and asset pricing, the paper then presents Lucas-type extensions for money and growth using a microfounded bank production of exchange credit as an alternative to money, as suggested by Lucas. The paper also shows how this leads to endogenous velocity, money causing inflation, and inflation causing lower economic growth, as in evidence. This implies that Lucas-based low stable inflation policy yields high economic growth and employment.