Lucas Critique


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Lucas Critique

The concept that one cannot draw accurate conclusions about present macroeconomic phenomena based purely on past data. The Lucas critique states that every policy change affects the circumstances under which different situations occur. Thus, a policy that worked under one set of circumstances may not apply under a different set. The name comes from a 1976 paper by Robert Lucas.
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The above scenario may also reflect the Lucas Critique [Lucas 1976], which suggests that if the estimated relationship changes whenever policy changes (or sample period changes), then policy conclusions based on the estimation are misleading.
This conceptual feature was popularized by several followingeconomists, notably Robert Lucas through the Expectations and the Neutrality of Money model (1972) and the so called Lucas Critique (1976), which constituted a milestone on the assumption of rational instead of adaptive expectations into macroeconomic models and whose original ideas remain in most of recently produced economic literature.
They would change as policy changed or as expectations about policy changed, leaving policy conclusions based on these models completely unreliable, (lire argument came to be called the Lucas critique.
These conclusions are obviously augmented when combined with the Lucas critique.
What appears to be a critique, but actually is a rehabilitation of stabilization policy, has its roots in the so called Lucas critique of macroeconomic models, which the Prize committee eventually endorsed in 1995.
For example, trying to take proper account of the Lucas critique when computing optimal policies in any non-trivial dynamic model can be quite difficult particularly in light of other difficulties such as time inconsistency.
The article highlights the important impact that the Lucas critique has had on both monetary policy, and the Bank's approach to modelling.
Any monetary policy prescriptions must deal with two macro ideas that have influenced the theoretical understanding of this topic for many years: the so-called Lucas critique, and the time inconsistency problem first discussed by Kydland and Prescott (1977), and then by Barro and Gordon (1983).
The Lucas critique taught policymakers that their actions could alter the terms of a trade-off they imagined were fixed.
Appendix A pursues a theme opened in the Lucas Critique about how drifting coefficient models bear on alternative theories of economic policy.
8) With these important caveats established, one of the main implications of the Lucas critique is that DSGE models have in principle an important advantage over other models in forecasting the effects of policy changes.
There have recently been a few attempts to argue that, whatever the theoretical attractions of rational expectations, evidence suggests that the Lucas critique is of little or no consequence empirically.