THE CURRENT DILEMMA IN MONETARY THEORY

In his study on money and inflation, Frank Hahn (1982b: 1) points to one horn of a dilemma facing neoclassical monetary theorists when he reminds us that: ‘The most serious challenge that the existence of money poses to the theorist is this: the best developed model of the economy cannot find room for it.’ But, if the best developed neoclassical model of the economy has no role for money, then Keynesian and monetarist analysis is hung on the other horn of the dilemma: based as it is on the neoclassical synthesis, it is proceeding without sound foundations in neoclassical theory. The neoclassical monetary theorist must, it seems, choose between monetary theory and sound theoretical foundations – a dilemma for the theorist.

Now, although Hahn's own position is narrowly based on a neo- Walrasian perspective, the dilemma to which he points applies to all neoclassical monetary theory, whether it be the Keynesian or monetarist version of the neoclassical synthesis or the Friedmanian quantity theory tradition. The objective of this study is therefore twofold: firstly, to show that the dilemma raised by Hahn applies to all the varieties of neoclassical monetary theory; and, secondly, to propose a solution to the dilemma by establishing where the foundations of monetary theory should be laid so as to avoid the quicksands of neoclassical theory.