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Chapter 25: Q:2 (page 675)

“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

Short Answer

Expert verified

The statement is true. This is because the non-rational expectations regarding the economic models impacted the stabilization policy.

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

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.

Non-rational expectations econometric models disregard the impact of changing expectations, making them unreliable for evaluating policy options. According to the Lucas critique, the impact of policy on inflation and output is influenced by expectations, making it more difficult to design a helpful policy.

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Most popular questions from this chapter

Suppose country A has a central bank with full credibility, and country B has a central bank with no credibility. How does the credibility of each country's central bank affect the speed of adjustment of the aggregate supply curve to policy announcements? How does this result affect output stability? Use an aggregate supply and demand diagram to demonstrate.

Suppose an econometric model based on past data predicts a small decrease in domestic investment when the Federal Reserve increases the federal funds rate. Assume the Federal Reserve is considering an increase in the federal funds rate target to fight inflation and promote a low inflation environment that will encourage investment and economic growth.

a. Discuss the implications of the econometric model’s predictions if individuals interpret the increase in the federal funds rate target as a sign that the Fed will keep inflation at low levels in the long run.

b. What would be Lucas’s critique of this model?

In general, how does credibility (or lack thereof) affect the aggregate supply curve?

Many economists are worried that a high level of budget deficits may lead to inflationary monetary policies in the future. Could these budget deficits have an effect on the current rate of inflation?

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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