NationMaster - Encyclopedia: Lucas critique

The Lucas Critique, named for Robert Lucas's work on macroeconomic policymaking, says that it's naive to try to predict the effect of a policy experiment based purely on correlations in historical data, especially high-level aggregated historical data. Robert Emerson Lucas, Jr. ... In statistics, aggregate data describes data combined from several measurements. ...

The basic idea pre-dates Lucas's contribution, but in a 1976 paper he drove the point home that this simple notion invalidated policy advice conditioned on the response of estimated system of equation models. Because the parameters of those models were not structural – that is, not policy-invariant – they would necessarily change whenever policy – the rules of the game – was changed. Any policy advice would then be potentially misleading. This argument called into question the prevailing large-scale econometric models that lacked foundations in dynamic economic theory. A model in macroeconomics is designed to simulate the operation of a national or international economy in terms of factors including the total amount of goods and services produced, total income earned, the level of employment of productive resources, and the general behavior of prices. ... A model in macroeconomics is designed to simulate the operation of a national or international economy in terms of factors including the total amount of goods and services produced, total income earned, the level of employment of productive resources, and the general behavior of prices. ...

The Lucas Critique implies that if we want to predict the effect of a policy experiment, we must model the "deep parameters" (preferences, technology and resource constraints) that govern individual behavior. We can then predict what individuals will do conditional on the change in policy, and add up individual behaviors to calculate the macroeconomic outcome. Preference (or taste) is a concept, used in the social sciences, particularly economics. ... In microeconomics, a production function expresses the relationship between an organizations inputs and its outputs. ... A Budget Constraint represents the combinations of goods and services that a consumer can purchase given current prices and his income. ...

The Lucas Critique was influential not only in casting doubt on many models of the economy but also in encouraging macroeconomists to build microfoundations for their models. Microfoundations had always been thought to be desirable; Lucas convinced many economists they were essential. Later Finn Kydland and Edward Prescott pioneered the use of microfoundations to formulate macroeconomic models. In economics, the term microfoundations refers to the microeconomic analysis of the behavior of individual agents such as households or firms that underpins a macroeconomic theory (Barro, 1993, Glossary, p. ... Finn E. Kydland (born 1943) is a Norwegian economist. ... Edward C. Prescott, born 26 December 1940 in Glen Falls/New York, received the Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel in 2004, sharing the award with Finn E. Kydland, for their contributions to dynamic macroeconomics: the time consistency of economic policy and the driving...

One important application of the critique is its implication that the historical negative correlation between inflation and unemployment, known as the Phillips Curve, could 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' inflation forecasts to rise, altering their employment decisions. CIA figures for world unemployment rates, 2006 Unemployment is the state in which a person is without work, available to work, and is currently seeking work. ... The Phillips curve is a historical inverse relation between the rate of unemployment and the rate of inflation in an economy. ... Look up forecast in Wiktionary, the free dictionary. ...

As an example you can think of the game chess: Players protect the the king because the game is lost once the king is lost. However, if the rules change and the game will be lost if a tower is lost, it would be foolish to assume that players will continue to play the same strategies as before. This article is about the Western board game. ...

See also

In economics, dynamic inconsistency, or time inconsistency, describes a situation where a decision-makers preferences change over time, such that what is preferred at one point in time is inconsistent with what is preferred at another point in time. ... // Business Cycles If we were to take snapshots of an economy at different points in time, no two photos would look alike. ... The Policy Ineffectiveness Proposition (PIP) is a new classical theory proposed in 1976 by Thomas J. Sargent and Neil Wallace based upon the theory of rational expectations. ... Although Goodharts law has been expressed in a variety of formulations, the essence of the law is that once a social or economic indicator or other surrogate measure is made a target for the purpose of conducting social or economic policy, then it will lose the information content that... Rational expectations is a theory in economics originally proposed by John F. Muth (1961) and later developed by Robert E. Lucas Jr. ... A model in macroeconomics is designed to simulate the operation of a national or international economy in terms of factors including the total amount of goods and services produced, total income earned, the level of employment of productive resources, and the general behavior of prices. ... Dynamic stochastic general equilibrium modeling (abbreviated DSGE or sometimes DGE) is a branch of applied general equilibrium theory that is increasingly influential in contemporary macroeconomics. ... The Lucas-Islands model is an economic model formulated by Robert Lucas, Jr. ... Methodological individualism is a philosophical orientation toward explaining broad society-wide developments as the accumulation of decisions by individuals. ...