Lucas critique
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The Lucas critique argues that it is naïve to try to predict the effects of a change in
The Lucas critique is significant in the history of economic thought as a representative of the paradigm shift that occurred in macroeconomic theory in the 1970s towards attempts at establishing micro-foundations.
Thesis
The Lucas critique was not new in 1976. The argument and the whole logic was first presented by Frisch (1938)[citation needed] and discussed by Haavelmo (1944),[3] among others. Related ideas are expressed as Campbell's law and Goodhart's law—but in a 1976 paper, Lucas drove to the point that this simple notion invalidated policy advice based on conclusions drawn from large-scale macroeconometric models. Because the parameters of those models were not structural, i.e. not policy-invariant, they would necessarily change whenever policy (the rules of the game) was changed. Policy conclusions based on those models would therefore potentially be misleading. This argument called into question the prevailing large-scale econometric models that lacked foundations in dynamic economic theory. Lucas summarized his critique:[4]
Given that the structure of an econometric model consists of optimal decision rules of economic agents, and that optimal decision rules vary systematically with changes in the structure of series relevant to the decision maker, it follows that any change in policy will systematically alter the structure of econometric models.
The Lucas critique is, in essence, a negative result. It tells economists, primarily, how not to do economic analysis. The Lucas critique suggests that if we want to predict the effect of a policy experiment, we should model the "deep parameters" (relating to
Shortly after the publication of Lucas's article,
The Lucas critique was an important methodological innovation. It does not invalidate that fiscal policy may be countercyclical, which some associate with John Maynard Keynes.
Examples
One important application of the critique (independent of proposed microfoundations) is its implication that the historical negative correlation between
For a simple example, consider the question of how much Fort Knox should spend on protection.[8] Fort Knox has never been robbed. Statistical analysis using high-level, aggregated data would therefore indicate that the probability of a robbery is independent of the resources spent on guards. The policy implication from such analysis would be to eliminate the guards and save those resources. This analysis would, however, be subject to the Lucas Critique, and the conclusion would be misleading. In order to properly analyze the trade-off between the probability of a robbery and resources spent on guards, the "deep parameters" (preferences, technology and resource constraints) that govern individual behaviour must be taken explicitly into account. In particular, criminals' incentives to attempt to rob Fort Knox depends on the presence of the guards. In other words, with the heavy security that exists at the fort today, criminals are unlikely to attempt a robbery because they know they are unlikely to succeed. However, a change in security policy, such as eliminating the guards, would lead criminals to reappraise the costs and benefits of robbing the fort. So just because there are no robberies under the current policy does not mean this should be expected to continue under all possible policies. In order to answer the question of how much resources Fort Knox should spend on protection, the analyst must model the "deep parameters" and strive to predict what individuals will do conditional on the change in policy.
See also
- Campbell's law
- Dynamic inconsistency
- Dynamic stochastic general equilibrium
- Game theory
- Goodhart's law
- Hasty generalization
- Macroeconomic model
- McNamara fallacy
- Methodological individualism
- Newcomb's paradox
- Policy-ineffectiveness proposition
- Problem of induction
- Rational expectations
- Real business cycles
- Structural estimation
- Variable change
References
- ISBN 0-444-11007-0. Archived(PDF) from the original on 2021-11-05.
- ISBN 0-12-619751-2.
- ^ Haavelmo, Trygve (July 1944). "The Probability Approach in Econometrics" (PDF). Econometrica. 12 (Supplement): iii-vi+1-115.
- ^ Lucas 1976, p. 41.
- ^ Lucas 1976, p. 21.
- S2CID 59329819.
- ^ David K. Levine. "Kydland and Prescott: Economists". Archived from the original on 2012-05-24. Retrieved August 12, 2012.
- ISBN 978-1594631405.
Further reading
- Favero, Carlo; .
- ISBN 0-631-14605-9.
- Marschak, Jacob (1953). "Econometric Measurements for Policy and Prediction". In Wood, W. C.; Koopmans, T. C. (eds.). Studies in Econometric Methods. New York: John Wiley & Sons.
- Sargent, Thomas (1996). "Expectations and the Nonneutrality of Lucas". Journal of Monetary Economics. 37 (3): 535–548. .
- Tesfatsion, Leigh (2010). "Notes on the Lucas Critique, Time Inconsistency, and Related Issues" (PDF).
- For interviews with Robert Lucas on his work, including the Lucas Critique, see www.ubs.com/robert-lucas[permanent dead link]