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Rational Expectations and the Lucas Critique

Makroekonomi 2, S1, FEUI, 2009 – Arianto A. Patunru. Rational Expectations and the Lucas Critique. Scarth Chapter 5. Intro. Lucas started his critique to Keynes in a 1972 paper

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Rational Expectations and the Lucas Critique

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  1. Makroekonomi 2, S1, FEUI, 2009 – Arianto A. Patunru Rational Expectations and the Lucas Critique Scarth Chapter 5

  2. Intro • Lucas started his critique to Keynes in a 1972 paper • Sargent (1975) and Wallace (1976) took it up. Main result: “policy irrelevance”; ie. systematic AD policy has no effect on real variables even in the SR • Scarth challenges this result; ie stabilization policy questions remain legitimate • The extent to which a policy is anticipated or unanticipated matters • Ratex does not rule out the role of errors. Only, there is no serial correlation among errors

  3. Statex and Ratex Compared

  4. Interpreting the AS Form (Eq 1) • Keynesian: inverted EAPC combined with labor demand fn and production fn. Here, δis stability condition. So deviation of output is due to deviation of LR labor supply schedules. • Classical: Lucas supply fn. Error term disappears (all market clears all the time), wage flexible. Y-gap vanishes (but need to assume nonlinear adjustment cost for stability condition)

  5. AD and AS with Statex Policy via AD, as AS independent of monetary policy

  6. AD and AS with Ratex Policy parameters gone; hence “policy irrelevance”. As m increases, AD up one-for-one; expected price also goes up one-for-one; hence AD and AS shifts up together  A to B immediately

  7. The Lucas Critique

  8. Sticky Wages and Prices

  9. Conclusions • Agents are not stupid. Ratex is sensible. • Intro to Ch 6: Keynesian policy proposals can come from a ratex analysis.

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