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The paper argues that Lucas (1972. ‘Expectations and the Neutrality of Money.’  Journal of Economic Theory  4 (2): 103–124) played a significant role in changing Friedman’s theoretical propositions of the 1970s, and that his restatement of Friedman’s (1968b.  Dollars and Deficits. Inflation, Monetary Policy and the Balance of Payments . Englewood Cliffs: Prentice-Hall International) address on monetarism helped Friedman refine his argument, regarding both theory and policy-making, in a consistent manner. First, the adoption of the rational expectations hypothesis eventually led to a confrontation with Friedman, whose own approach to probability, based on subjective uncertainty, originated in his early joint work with Savage. Second, Lucas’ modelling of the aggregate supply function undermined Friedman’s earlier approach to the interrelationships between prices and quantities, but also helped remind Friedman of his Marshallian lineage. Lastly, Lucas’s monetary cycle theory, based on an extraction signal problem that was quickly criticized and abandoned, compelled Friedman to give a firmer theoretical foundation to his monetary policy rule based on a constant rate of growth in money supply, thanks to his earlier approach of subjective uncertainty and personal probability.

Lucas and Friedman: The Challenges of Rational Expectations-Based Monetary Cycles for Adaptive Expectations-Based Monetary Long Trends