The Evolution of Financial Institutions and the Performance of the Economy

Jack Gurley punctured the pretensions of Friedmanian monetary theory some twenty-five years ago when he characterized it as holding that 6money is a veil, but when the veil flutters, real output sputters.' Gurley's words exposed the contradiction of monetarism-that money is neutral but that monetary changes are the main causal factors in the real income and employment changes of business cycles. The proposition that money is neutral and the axiom of reals that underlie neoclassical theory are inconsistent with the view that money matters in anything besides the determination of the nominal price level.2 Gurley's paradox was the inspiration for Robert E. Lucas's key neutrality-of-money paper. As is well known, the fundamental construct of the neoclassical tradition is a labor market represented by supply and demand curves in which the quantities supplied or demanded are functions of the real wage and employment. Lucas, and Milton Friedman before him, construct mechanisms by which those who supply and those who demand, interpret, or perceive nominal price and wage changes (which to both Lucas and Friedman are due to changes in the money supply) in different ways. Because of these imperfections, changes in the money supply will lead to changes in real output. In Lu