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Chapter 25: Q:1 (page 675)

What does the Lucas critique state about the limitations of our current understanding of the way in which the economy works?

Short Answer

Expert verified

The Lucas critique in Economics indicates to us the effect that will be carried upon the policy of price inflation and also that the outputs will be depending on the expectations that will help us make the economic policy more effective.

Step by step solution

01

Step:1 Introduction

In a 1976 article, prominent economist Robert Lucas described how macroeconomic models might be exploited to evaluate changes in economic policy. Lucas' critique is the name given to this piece.

02

Step:2 Explanation

Traditional ways of formulating and evaluating policies, according to Lucas, do not take into account how people would react to politics. This is significant because people's actions have a significant impact on economic policy. People do not always have adaptive expectations, and political creators should not presume that they do. According to Lucas, each policy change enacted by rational workers and businesses will be met with adjustment, depending on the nature of the change and its impact. Economists must evaluate the impact of politics on people's expectations, according to Lucas.

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Most popular questions from this chapter

Go to the St. Louis Federal Reserve FRED database, and find data on the core PCE price index (PCEPILFE) and the spot price of a barrel of oil (WTISPLC). For both variables, convert the units setting to "Percent Change from Year Ago, " and download the data from 1960 to the most recent available data.

a. Identify periods in which oil price inflation is 80%or higher.

b. In the periods identified in part (a), how many months was oil price inflation 80% or higher? What was the average core inflation rate during each of those episodes?

c. Based on your answers to parts (a) and (b) above, what can you conclude about the credibility of more recent monetary policy compared to its credibility in the earlier periods?

Robert Lucas won the Nobel Prize in economics. Go to http:/nobelprize.org/nobel_prizes/economics/ and locate the press release on Robert Lucas. What was his Nobel Prize awarded for? When was it awarded?

“The Lucas critique by itself casts doubt on the ability of discretionary stabilization policy to be beneficial.” Is this statement true, false, or uncertain? Explain your answer

Various survey-based measures of inflation expectations are available reflecting consumer, market, and economists" outlooks. For instance, the Survey of Professional Forecasters (SPF) is available from the Philadelphia Federal Reserve at https//www.philadelphiafed.org/research-and-data/ real-time-center/survey-of-professional-forecasters/, while the well-known University of Michigan consumer inflation expectations survey is available at https://fred st1ouisfed org/series/MICH. Compare the most recent readings of inflation expectations of the SPF and Michigan survey to actual CPI inflation. In general, which one seems to be more accurate?

Suppose two countries have identical aggregate demand curves and potential levels of output, and γis the same in both countries. Assume that in 2019 , both countries are hit with the same negative supply shock. Given the table of values below for inflation in each country, what can you say, if anything, about the credibility of each country's central bank? Explain your answer.
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