After encountering the Lucas critique
, the present study finds that around 42 percent of the output loss is due to the ensuing tight monetary policy.
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.
Economists at universities started working on developing a modeling framework that did not violate the Lucas critique
. Monetary policymakers meanwhile continued to work with existing large-scale models since they were the only available framework for policy analysis.
As noted earlier, the Chari and Kehoe (2006) survey of 'modern macroeconomics' lists the 'Lucas critique
of policy evaluation' and the time inconsistency critique of discretionary policy amongst the three significant developments in practical macroeconomics.
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.
Second, those of you who are familiar with the macroeconomics literature are no doubt aware of the relevance of the Lucas Critique
to these issues.
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.