Lucas Critique

5 Key excerpts on "Lucas Critique"

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  A History of Macroeconomics from Keynes to Lucas and Beyond

  • Michel De Vroey(Author)
  • 2016(Publication Date)
  • Cambridge University Press

    (Publisher)

  But, in my opinion, there was also an ideological dimen- sion. 24 Keynesians associated the rational expectations revolution with conser- vatism. They viewed it as going against their ideology and hence they wanted to fight it. There is no doubt that the policy conclusions of Lucas’s model as well as those of subsequent RBC models were conservative. The real point, however, is to know whether these policy conclusions were so deeply built-in that their removal was highly improbable. If that was the case, traditional Keynesians were right to resist. If it was not, another strategy was possible, following Friedman’s footsteps in his Presidential Address, namely to try to modify the prevailing theory in a way that at one and the same time leads to its enrichment and to a reversal of established policy conclusions. Today after the ascent of second generation new Keynesian models, we may realize with the advantage of hindsight that such a subversion was conceivable. 24 As argued in Chapter 4, I am of the opinion that having an ideological motivation in theory should not be considered reprehensible. 224 A History of Macroeconomics from Keynes to Lucas and Beyond 13 Reacting to Lucas: First-Generation New Keynesians In 1991, the MIT Press published a two-volume book edited by Gregory Mankiw and David Romer entitled New Keynesian Economics (Mankiw and Romer 1991). 1 It gathered articles that had in common to react to Lucas’s criticisms of Keynesian macroeconomics. Their authors admitted that some of these criticisms were valid and could not be easily dismissed. In particular, they accepted the microfoundations requirement, that is, the need to depict agents as behaving in an optimizing way. However, this acceptance did not make them Lucasian. On the contrary, their aim was to rehabilitate what they regarded as the basic Keynesian ideas, involuntary unemployment, sluggishness and money non-neutrality.

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  The Theory of Economic Policy in a Strategic Context

  • Nicola Acocella, Giovanni Di Bartolomeo, Andrew Hughes Hallett(Authors)
  • 2012(Publication Date)
  • Cambridge University Press

    (Publisher)

  This chapter argues that drift can better be explained by formu- lating public decision making in an explicitly strategic manner. This means considering the strategic interactions between policymakers, or between policymakers and private agents, extended perhaps to include learning and the possibility of model misspecifications. 4.4 Overcoming the critique The Lucas Critique is undoubtedly well founded and raises both prac- tical and theoretical problems. At a practical level, the amount by which parameters change in response to the change in economic pol- icies is important. If the change is small, designing policy on the basis of previously estimated values will be broadly reliable. Obviously, reli- ability also depends on the data set used to estimate the parameters: the larger the set and the more it encompasses situations in which different policies were in use, the less the parameters will vary and the greater is the reliability of the model’s determination of optimal pol- icies. In the 1970s many macroeconomic relationships broke down as a consequence of major changes in the policy regime (for example, the Phillips curve) as agents adjusted their behavior and future expecta- tions to fit the new environment. From a theoretical point of view, the Lucas Critique underscores the presence of reciprocal interactions between the behavior of pri- vate agents and that of the government. In particular, the private sec- tor plays an active rather than passive role, changing its behavior as expectations about government behavior change. 6 The critique is a response to the fact that the traditional approach to the economic pol- icy does not admit this sort of interaction. Once we recognize the fact that the behavioral functions of private agents can themselves change in relation to public choices, we have to accept that both government 5 In Section 4.5 we formally show the link between REs and strategic behavior in a dynamic model.

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  The Representative Agent in Macroeconomics

  • James E Hartley, James E. Hartley(Authors)
  • 2002(Publication Date)
  • Taylor & Francis

    (Publisher)

  4 BEYOND TASTE AND TECHNOLOGY PARAMETERS IN MACROECONOMICS

  THE Lucas Critique

  As we discussed in Chapter 3 , perhaps the most frequently mentioned rationale for using representative agent models in macroeconomics is the Lucas Critique. In this chapter, we want to examine carefully the Lucas Critique and see how it relates to representative agent models.

  Lucas (1976) begins by arguing that an economy at time t can be defined as a set of three vectors: (a) the set of endogenous variables, yt ; (b) the set of exogenous variables, xt ; and (c) the set of random shocks, εt . Traditional macroeconomics would use these vectors in a model of the form:

  (4.1)

  where θ is a set of fixed parameters. The task for the economist is to define the set (F,θ). This is usually done by specifying the functional form, F, and then empirically deriving the values of the parameters in θ.

  Let us be more concrete. Consider the simple model:

  (4.2)

  The functional form, F, is explicitly stated by the fact that yt+1 depends only on xt . A different F could be:

  (4.3)

  In equation (4.2 ), the θs are the βs; in equation (4.3 ), the θs are the αs and the βs. Note that the Fs and the θs are not completely independent entities. The choice of F will affect the values of θ. One could start with the functional form in (4.3 ) and derive the form in (4.2 ) with the appropriate values of θ, i.e., if the αs are all zero. However, in practice, the Fs and θs are distinct. A researcher chooses F; i.e., he chooses whether to derive values for α(equation (4.3 )) or to set them a priori equal to zero (equation (4.2 )). Given the functional form, the θs are then derived.

  With a model of the form in equation (4.1 ), policy analysis is simple. One merely considers a policy change, determines how the xs will be affected, puts the new xs into the model, and derives the y

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  The Friedman-Lucas Transition in Macroeconomics

  A Structuralist Approach

  • Peter Galbács(Author)
  • 2020(Publication Date)
  • Academic Press

    (Publisher)

  If we do not discredit the idea of a realist Lucas prejudicially, his considerations on the decision problems of agents will show a radically different picture of his theory and methodology. The point of departure from the widely accepted account is the recognition of the simple fact that empirical success does not necessarily imply F53-like instrumentalism. For realists it is also important to have good predictions as realists conceive satisfying empirical performance as a sign of a grip on reality. Friedman’s instrumentalism is a simple case as he approved of this account as the correct summary of his methodological stance and the vast majority of the F53-interpretations also subscribe to this reading. Our key question was whether Lucas put forward some purposes similar to the instrumentalist claims embedded in F53. As semirealism argues that macro-level phenomena should be traced back to micro-level properties, the key to the alleged realism of the Lucasian microfoundations project lies in the way he represented agents. Likewise, if Lucas had really built his models in the 1970s in an instrumentalist fashion, instrumentalism could also be identified at this level. An emphasis upon empirical performance at the macro-social level is indifferent in these terms.

  His texts do not support an instrumentalist reading of Lucas—if they do, it is only at a superficial level at best. His main objection to Keynesian models regarded the assumed constancy of the underlying parameters. As he argued, these models prove useless in cases where economic policies change. As a change in the policy rule drives agents to change the behavioural rules they previously followed, the purpose of economic theory is to understand the individual’s decision problem, or more specifically, to understand how a regime change influences individual behaviour. We can thus find the extremely individualist methodological stance according to which all macro-social phenomena should stem from the agents. As a consequence, the most important question of the analysis above regarded Lucas’s ideas on the representation of entity properties.

  It is important to realize that when Lucas suggested a reduction to individual decisions (to the extent it was feasible), the thing he had in mind was a far cry from a mere heuristic device. It is more than the fact that the choice-theoretic framework he applied led to predictions well mimicking real outcomes that justified its use. Lucas regarded choice theory as causally adequate and realist since macroeconomic phenomena really emanate from individual decisions, and it also explains the predictive success of models. Lucas suggested no ad hoc or pragmatist assumptions but understanding and modelling the decision problem of real economic agents. Understanding business cycles amounts to the understanding of how changes in the money stock, conceived as evident shocks, can lead to large-scale real economic fluctuations with the transmission of individual decisions. Lucas established the consistency with the available evidence and data as a requirement at two distinct levels. Beyond good empirical performance at the macro level the consonance with micro-economics and micro-level data is also an explicit requisite. In his models analysed above he designed the prototypical individual by exploiting the available theoretical and empirical results about the decision problem of real economic agents. For Lucas individual decision is so obvious a basis that the choice-theoretical framework loses its hypothetical character.

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  Alternative Theories of the State

  • S. Pressman(Author)
  • 2006(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  A rising debt, with rising interest burdens, increases the likelihood of a government default. Furthermore, Buchanan argued that future generations suffer from the deficit because they must pay higher taxes. Overall, Buchanan, Burton and Wagner (1978) see Keynesian econom- ics "as a disease that over the long run can prove fatal for the survival of democracy". It loosens the moral restraint on politicians to act in morally acceptable fashion and it leads to the false belief that since we owe the money to ourselves, there is nothing wrong with running state deficits. Rational expectations takes a slightly different approach in its critique of Keynesian economics. Following from the seminal article by Muth Steven Pressman 119 (1961), Robert Lucas brought the standard microeconomic assumptions about individuals into macroeconomic analysis and insisted that all macroeconomic modeling incorporate rational expectations. This meant that individuals are seen as being rational, self-interested, and very smart. These rational economic agents will react quickly to any changes in government economic policy, and they will react in ways that maximize their own utility or well-being. Because human beings change their behavior in response to changes in the world, and in response to how they view the world, Lucas (1976; Lucas & Sargent, 1978) criticized the Keynesian assumption that all macroeconomic relationships would remain unchanged in the face of policy changes enacted by policy makers. For rational expectations economists, rational individuals who seek to maximize their own well- being should change their behavior in the face of changing economic policy. This, in turn, will change macroeconomic relationships because "a change in policy necessarily alters some of the structural parame- ters...in a highly complex fashion" (Lucas & Sargent, 1978: 52).

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