LUCAS CRITIQUE

The Lucas critique, named for Robert Lucas′work on macroeconomic policymaking.

He argues that it is naive to try to predict theeffects of a change in economic policy entirelyon the basis of relationships observed inhistorical data, especially highly aggregated

historicaldata .

"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 predictwhat individuals will do, taking into account thechange in policy, and then aggregate the

individualdecisions to calculate the macroeconomic effects

ofthe policy change.

The Lucas critique was influential because it encouraged macroeconomists to build micro foundations for their models.

Micro foundations had always been thought to be desirable; Lucas convinced many economists they were essential. 

EXAMPLES

Fort Knox has 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 the Phillips Curve,

Would break down if the monetary authoritiesattempted to exploit it. Permanently raisinginflation in hopes that this would permanentlylower unemployment would eventually cause

firms‘inflation forecasts to rise, altering theiremployment decisions.

Just because high inflation was associated with low unemployment under early-twentieth-century monetary policy 

This does not mean we should expect high inflation to lead to low unemployment under all alternative monetary policy regimes