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Adaptive expectations, underparameterization and the Lucas critique

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  • Evans, George W.
  • Ramey, Garey

Abstract

A striking implication of the replacement of adaptive expectations by Rational Expectations was the "Lucas Critique," which showed that expectation parameters, and endogenous variable dynamics, depend on policy parameters. We consider this issue from the vantage point of a bounded rationality, where for transparency we model bounded rationality by means of simple adaptive expectations.We show that for a range of processes, monetary policy remains subject to the Lucas critique. However, there are also regimes in which the expectation parameter is locally invariant and the Lucas critique does not apply.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 53 (2006)
Issue (Month): 2 (March)
Pages: 249-264

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Handle: RePEc:eee:moneco:v:53:y:2006:i:2:p:249-264

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Web page: http://www.elsevier.com/locate/inca/505566

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  1. Milton Friedman, 1957. "Introduction to "A Theory of the Consumption Function"," NBER Chapters, in: A Theory of the Consumption Function, pages 1-6 National Bureau of Economic Research, Inc.
  2. Milton Friedman, 1957. "A Theory of the Consumption Function," NBER Books, National Bureau of Economic Research, Inc, number frie57-1, April.
  3. Cooley, Thomas F & Prescott, Edward C, 1976. "Estimation in the Presence of Stochastic Parameter Variation," Econometrica, Econometric Society, vol. 44(1), pages 167-84, January.
  4. George W. Evans & Seppo Honkapohja, 1993. "Adaptive forecasts, hysteresis, and endogenous fluctuations," Economic Review, Federal Reserve Bank of San Francisco, pages 3-13.
  5. Cooley, Thomas F & Prescott, Edward C, 1973. "Tests of an Adaptive Regression Model," The Review of Economics and Statistics, MIT Press, vol. 55(2), pages 248-56, May.
  6. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
  7. Cooley, Thomas F & Prescott, Edward C, 1973. "An Adaptive Regression Model," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 14(2), pages 364-71, June.
  8. Fischer, Stanley, 1977. "Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 191-205, February.
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