“Rational Expectations” Theories Explicitly Acknowledge the Postulate of “Money Neutrality”

The theoretical revolution dubbed ‘rational expectations’, which occurred around mid-1970s, came to reinforce the classical dichotomy [between monetary/nominal values and real values] that had already been dominating economic thought for over two centuries. The introduction of expectations of variations in the purchasing power of money was grounded on the postulate that economic agents can understand the connection between money and the price level. On the assumption that economic agents do not suffer from the ‘money illusion’, rational expectations theories expected them to be able to sieve through market signals and discriminate between nominal and real changes. Lucas (1975) and Sargent and Wallace (1976) therefore concluded that only real changes affect real decisions, and that variations in the purchasing power of money are neutralized if correctly anticipated (McCallum 1980)—not only in the long run, but in the short run as well (Kaldor 1970; Lines and Westerhoff 2010). The dichotomy between the monetary and the real sectors of the economy was in this way restated in even stronger terms, with the postulate of money neutrality explicitly acknowledged.

—Carmen Elena Dorobăț, “Cantillon Effects in International Trade: The Consequences of Fiat Money for Trade, Finance, and the International Distribution of Wealth” (PhD diss., Université d'Angers, 2015), 53.