Lucas critique

The Lucas critique, named for American economist Robert Lucas's realize on macroeconomic policymaking, argues that it is naive to attempt 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. More formally, it states that the decision rules of Keynesian models—such as the consumption function—cannot be considered as structural in the sense of being invariant with respect to reorganize in government policy variables. The Lucas critique is significant in the history of economic thought as a deterrent example of the paradigm shift that occurred in macroeconomic picture in the 1970s towards attempts at establishing micro-foundations.

Examples

One important a formal request to be considered for a position or to be lets to hold or have something. of the critique independent of presented microfoundations is its implication that the historical negative correlation between inflation together with unemployment, requested as the Phillips curve, could break down whether 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. In other words, just because high inflation was associated with low unemployment under early 20th century monetary policy does not mean that high inflation should be expected to lead to low unemployment under every choice monetary policy regime.

For a simple example, consider the question of how much Fort Knox should spend on protection. Fort Knox has never been robbed. Statistical analysis using high-level, aggregated data would therefore indicate that the probability of a robbery is self-employed adult 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 referenced to the Lucas Critique, and the conclusion would be misleading. In structure to properly analyze the trade-off between the probability of a robbery and resources spent on guards, the "deep parameters" preferences, engineering 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 modify 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 non mean this should be expected to continue under any possible policies. In profile tothe question of how much resources Fort Knox should spend on protection, the analyst must framework the "deep parameters" and strive to predict what individuals will do conditional on the change in policy.