The Lucas critique: A Lucas critique

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The Lucas critique has been and continues to be the cornerstone of modern macroeconomic modelling. In this note we apply the Lucas critique to macroeconomic modelling using deep rational expectations. In conclusion we point out that Lucas’ call for rational expectations models that provide useful economic policy advice has yet to be heeded.

Posted for comments on 21 Feb 2018, 12:13 pm.

Comments (1)

  • Erich Pinzon-Fuchs says:

    In his paper, Christian Müller-Kademann proposes a re-interpretation of the Lucas Critique through the introduction of the concept of deep rational expectations (DRE). The author argues that DRE would take the Lucas Critique to another level, since the rational expectations (RE) framework would be applied not only to a particular model based on which economic agents build their expectations about the consequences of particular policies but also to the problem of how agents select a particular model among others in the first place. In order to apply the Lucas Critique to the model selection problem, the author claims that it is necessary to introduce John Maynard Keynes’s concept of fundamental uncertainty, since “the concept of (fundamental) uncertainty […] is potentially able to reconcile rationality, model consistent expectations and the Lucas Critique” (p. 9). Yet, although the author’s proposition is interesting and quite bold, the author does not discuss it sufficiently, nor does he provide a clear alternative on how to put in place a research agenda based on his idea of DRE. Given that the paper has important normative elements, there is a need for both a more thorough and detailed discussion of the actual use of DRE in macroeconomic modelling, and for a concrete illustration of its use. In conclusion, I think that the paper is interesting and has potentially something important to say. However, in its present form, the paper does not present its arguments in a way that is sufficiently thorough. The author’s over-optimistic and uncritical interpretation of the Lucas Critique makes more harm to the author’s arguments than it helps him in making his point. In this sense, most of the ideas expressed in this paper could benefit from a reflexive examination of the history of the Lucas Critique that does not stem from the “standard narrative” of the history of macroeconomics built by Robert Lucas himself and by other practitioners of macroeconomics.

    Specific comments

    1) One of the main propositions in the paper, namely that macroeconomics should introduce Keynes’s concept of fundamental uncertainty is, in my opinion, insufficiently treated. Indeed, the author refers to Keynes’s (1937) paper as the major source to understand this concept, and yet Keynes does not thoroughly develop this concept in that particular piece. I think that the author’s proposition needs to be thoroughly researched and discussed and that, to do so, the author should study and refer to Keynes (1921) as well as to the secondary literature that also focuses on Keynes’s ideas on uncertainty and probability. Some important references in this sense are Lawson (1985a; 1985b) and Carabelli (1988).

    2)The author presents the Lucas Critique in an over-optimistic and uncritical way. This has to do, in particular, with the assumption of an uncritical stand towards the “standard history” of macroeconomics as defined by Duarte and Lima (2012). The author’s uncritical acceptance of the standard narrative is revealed at different points in the paper. For example, when the author asserts that the Lucas Critique was a “devastating attack on the […] common approach to macroeconometric modelling” (p. 2); that the critique was “convincing” and “successful,” and that macroeconomic models had “achieve[d] consistency” (p. 3) thanks to the Lucas Critique. In addition, the adoption of the standard narrative leads the author to adopt a vision about the macroeconometric models of the 1960s and 1970s that is not necessarily fair. Following this vision, the author does not recognise, as does Lucas (1976, p. 20, footnote 3) for instance, that macroeconometricians were well aware of the fact that the implementation of policies could change the agents’ behaviour and hence the structure of the model, making the model unable to evaluate economic policies. Lucas (1976) explicitly recognises that Jan Tinbergen and Jakob Marschak were aware of this problem since, at least, the 1940s.

    3) The author considers that the Lucas Critique necessarily implies the use of the rational expectations hypothesis. Yet, a closer look at Lucas’s (1976) paper shows that this is not necessarily the case. In fact, Lucas (1976) argues that the macroeconomic models which have been built to make policy evaluation, should take into account a careful description of the optimising behaviour of individual economic agents and in particular of their reactions to changes in economic policy. The rational expectations hypothesis is only one way to consider these reactions, but it is not the only way (see Goutsmedt et al. 2015). This interpretation of the Critique is quite common and has to do with the spread of a “standard narrative” of the history of macro (and of the Lucas Critique). In this sense, the author should precise that he is not taking the Lucas Critique itself to another level, but rather the rational expectations hypothesis.

    4) The author claims that “the message of the Lucas Critique is an ontological one” (p. 9), meaning that the Lucas Critique, applied at the level of the model selection problem, can tell us something important about the way uncertainty works in the real world. In this sense, and citing John Stuart Mill (1844) hastily, the author claims that the Lucas Critique “seriously challenge[s] if not outright reject[s]” economists’ “relentless search for newer, better models” and their “ontological view of an underlying truth that waits to be discovered” (p. 9). However, hardly any economist would define her/his job as that of seeking for an “underlying truth that waits to be discovered.” Much more evidence and historical work should be undertaken here in order to support the author’s claim.

    Minor comments

    – The abstract is incomplete and should be revised. The paper pretends to do more than announced in the abstract.

    -The author claims that “criticism of the Lucas Critique has become the subject of research agendas in its own right” (p. 4) and cites our paper Goutsmedt et al. (2015). Just to clarify, our “research agenda” is not to criticise the Lucas Critique, but to reflect on the narratives that are built around the history of the Lucas Critique (and of the history of macro in general). The title of our paper “Criticizing the Lucas Critique” must be read together with its subtitle “Macroeconometricians’ response to Robert Lucas,” meaning that it is not us (the historians) who criticise Lucas, but that we want to recover and study the macroeconometricians’ contemporary reactions to the Lucas Critique, which have been left aside in the “standard narrative.” Our research, again, is focused on criticising the “standard narrative” of the history of macroeconomics which has been produced by practitioners of macroeconomics, including Lucas, in order to get a richer and broader narrative that takes into account all the players of particular episodes in the history of macroeconomics. In this project, we follow other historians of macro such as Duarte and Lima (2012) and Forder (2014), among many others.

    Supplementary references:

    Carabelli, Anna M. (1988) On Keynes’s Method. London: The MacMillan Press Ltd.

    Duarte, Pedro and Gilberto Lima (2012) “Introduction: Privileging micro over macro? A history of conflicting positions,” in Duarte and Lima (eds.) Micorfoundations reconsidered: the relationship of micro and macroeconomics in historical perspective. Cheltenham: Edward Elgar.

    Forder, James (2014) Macroeconomics and the Phillips Curve Myth. Oxford University Press.

    Goutsmedt, A. et al. (2015) “Criticizing the Lucas Critique: Macroeconometricians’ Response to Robert Lucas,” CES Working Papers, 2015.59.

    Keynes, John M. (1921) A Treatise on Probability. London: Macmillan and Co., Limited.

    Lawson, Tony (1985a) “Keynes, Prediction and Econometrics.” In Lawson, Tony and Hashem Pesaran (eds.) (1985). Keynes’s Economics: Methodological Issues. London: Croom Helm.

    Lawson, Tony (1985b) “Uncertainty and Economic Analysis.” The Economic Journal, Vol. 95, No. 380, pp. 909-927.

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