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.
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.
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.
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.
Although the Lucas critique is sometimes seen to be an attack on a modeling strategy (without rational expectations, the macroeconometric modeler cannot get it right), Lucas's point is not "if we only knew how the estimates would change, we could continue to use the old strategy of policy analysis.
Using such models, the unemployment rate is found to have a significant additional effect on the estimated size of union wage premium (Jarrell and Stanley 1990), that the author's sex affects his or her estimate of the magnitude of gender wage discrimination (Jarrell and Stanley 1995), and that variations in model specifications can have a large impact on evidence regarding the Lucas critique (Stanley 1995).
Under the Ricardian equivalence hypothesis, the timing of budget surpluses and deficits--and therefore the perceived fiscal policy rule--is unimportant, and the Lucas critique does not apply.