LUCAS

CRITIQUE

TheLucas critique, named forRobert Lucas

work on macroeconomic policymaking.

He argues that it is naive to try to predict the

effects of a change in economic policy entirely
on the basis of relationships observed in
historical data, especially highly aggregated historical
data .

"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."

Deep parameters"
Preferences
Technology
Resource constraints
These deep parameters must be used to predict
what individuals will do,taking into accountthe
change in policy, and then aggregate the individual
decisions to calculate the macroeconomic effects of
the policy change.

The Lucas critique was influential because it

encouraged macroeconomists to buildmicro
foundationsfor their models.
Micro foundations had always been thought to be
desirable; Lucas convinced many economists they
were essential.

EXAMPLES

Fort Knoxhas never been robbed

This does not mean the guards can safely be
eliminated
The incentive not to rob Fort Knox depends on the
presence of the guards.
The heavy security that exists at the fort today,
criminals are unlikely to attempt a robbery because
they know they are unlikely to succeed.

But 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.

PHILIPS CURVE AND LUCAS CRITIQUE

The negative correlation between inflation
and unemployment, known as thePhillips
Curve,
Would break down if the monetary authorities
attempted to exploit it. Permanently raising
inflation in hopes that this would permanently
lower unemployment would eventually cause firms
inflationforecaststo rise, altering their
employment decisions.

Just because high inflation was associated with

low unemployment under early-twentiethcenturymonetary policy

This does not mean we should expect high

inflation to lead to low unemployment under all
alternative monetary policy regimes