A Study on Lucas’ “Expectations and the Neutrality of Money’’ ()

Masayuki Otaki

Institute of Social Science, University of Tokyo, Tokyo, Japan.

**DOI: **10.4236/tel.2012.25081
PDF
HTML XML
4,733
Downloads
7,654
Views
Citations

Institute of Social Science, University of Tokyo, Tokyo, Japan.

This short article shows that the functional equation on the equilibrium price function is more complicated than that considered by Lucas [1], and that modification is required to complete the proof. Furthermore, we shall provide a sufficient condition that guarantees the uniqueness of the equilibrium price function.

Share and Cite:

Otaki, M. (2012) A Study on Lucas’ “Expectations and the Neutrality of Money’’. *Theoretical Economics Letters*, **2**, 438-440. doi: 10.4236/tel.2012.25081.

1. Introduction

This study aims to show that some additional condition is necessary for the operator in Lucas [1] to become the contraction mapping. This is because transformation between the functional equations on the equilibrium price function is not equivalent. We also provide a sufficient condition such that can become the contraction mapping.

The paper is as follows. Section 2 rewrites the functional equation in the correct form and shows that unlike the original paper, the contraction mapping method cannot be easily applied. A sufficient condition for the uniqueness of the equilibrium price function is provided in Section 3. Section 4 contains brief concluding remarks.

2. Equivalent Transformation

Lucas [2] admits that there is no guarantee that and is a one-to-one correspondence, and some reservation is necessary for the conclusion. Furthermore, he also recognizes that the equilibrium price function should be specified as

for determining the unique equilibrium. However, besides these problems, the transformation between functional equations below is not equivalent. The aim of the study is to clarify that fact and show rather restrictive condition for supporting the original result.

Lucas [1] firstly derives the following functional equation as the equilibrium condition of money market:

(1)

where is the realized value of the increment of money during the current period. also denotes the realize value of the population of the young generation. are random variables of each exogenous shock during the next period. We must note the existence of the random variable. Although is an available information through the inverse equilibrium price function, cannot be directly observed alone by household. Thus, when singly appears in the functional equation, it should be treated as the random variable.

The right-hand side of (1) means the marginal utility of the current consumption, and the left-hand side implies the expected marginal utility of the future consumption. Namely, functional Equation (1) is the Euler equation in this model. Lucas [1] asserts that (1) is equivalently transformed into

(2)

However, (1) and (2) is not equivalent. We shall deal with this problem. This transformation assumes. Nevertheless, as discussed above, is a realized vale (real number) of the random variable (measurable function). Hence they cannot be cancelled out. The equivalent transformation from (1) to (2) is

(3)

Let us define

,

and. Using these definitions (1) is transformed into

Then the correct form of the operator in the Appendix of Lucas [1] becomes

(4)

Consequently, inequality (A.6) in Lucas’ [1] appendix

is modified as

(5)

It is noteworthy that are functions of in (5). Let us denote those functions as

(6)

Accordingly, (5) becomes

(7)

Let us define as

Consequently, (7) is transformed into

(8)

Applying the mean value theorem and Lucas’ [1] assumptions (A.2) and (A.3)

to (8), we finally obtain

(9)

Since generally, the original paper has not succeeded in proving that the operator is the contraction mapping.^{1} Some additional condition is necessary for completing the proof.

3. A Sufficient Condition

Since the difficulty arises from the fact that (5) explicitly depends on, we assume that the function is multiplicatively separable. Namely, suppose that satisfies

(10)

In this case, (5) is modified as

(11)

This inequality is essentially identical to (A.6), and thus, becomes the contraction mapping.

Nevertheless, the function, which satisfies the functional Equation (10), is confined to power functions (See Small [3]). Hence,

(12)

(A.3) also requires. To sum up, CRRA (Constant Relative Risk Aversion) family, whose relative risk aversion is located within, is the only function satisfying the sufficient condition (10).

4. Conclusion

We have shown that the functional equation of the equilibrium price function is more complicated than that considered by Lucas [1]. Hence, some additional condition is necessary to employ the contraction mapping method. This study finds that if belongs to CRRA family of low relative risk aversion, the uniqueness of the solution is guaranteed. To sum up, Lucas' assertion on the neutrality of money under uncertainty hold only rather restrictive utility functions than has been considered.

NOTES

does not necessarily hold. For example, when is a stricktly increasing function, is stricktly decreasing, then

holds.

Conflicts of Interest

The authors declare no conflicts of interest.

[1] | R. E. Lucas Jr., “Expectations and the Neutrality of Money,” Journal of Economic Theory, Vol. 4, No. 2, 1972, pp. 103-124. doi:10.1016/0022-0531(72)90142-1 |

[2] | R. E. Lucas, Jr., “Corrigendum to `Expectations and the Neutrality of Money,” Journal of Economic Theory, Vol. 31, No. 1, 1983, pp. 197-199. doi:10.1016/0022-0531(83)90031-5 |

[3] | C. G. Small, “Functional Equations and How to Solve Them,” Springer Science + Business Media, New York, 2007. |

Journals Menu

Contact us

+1 323-425-8868 | |

customer@scirp.org | |

+86 18163351462(WhatsApp) | |

1655362766 | |

Paper Publishing WeChat |

Copyright © 2024 by authors and Scientific Research Publishing Inc.

This work and the related PDF file are licensed under a Creative Commons Attribution 4.0 International License.