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The Lucas critique and the stability of empirical models

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  • Thomas A. Lubik

    (Research Department, Federal Reserve Bank of Richmond, VA, USA)

  • Paolo Surico

    (London Business School, London, UK, and CEPR)

Abstract

This paper reconsiders the empirical relevance of the Lucas critique using a DSGE sticky price model in which a weak central bank response to inflation generates equilibrium indeterminacy. The model is calibrated to capture the magnitude of the historical shift in the Federal Reserve's policy rule. Using Monte Carlo simulations and a backward-looking model of aggregate supply and demand, we find that shifts in the policy rule induce breaks in both the reduced-form coefficients and the reduced-form error variances. When the instability of the reduced-form error variances is accounted for, the Lucas critique is found to be empirically relevant. Copyright © 2009 John Wiley & Sons, Ltd.

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File URL: http://hdl.handle.net/10.1002/jae.1129
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Bibliographic Info

Article provided by John Wiley & Sons, Ltd. in its journal Journal of Applied Econometrics.

Volume (Year): 25 (2010)
Issue (Month): 1 ()
Pages: 177-194

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Handle: RePEc:jae:japmet:v:25:y:2010:i:1:p:177-194

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Citations

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Cited by:
  1. Bilbiie, Florin O. & Straub, Roland, 2012. "Asset market participation, monetary policy rules and the great inflation," Working Paper Series 1438, European Central Bank.
  2. Thomas A. Lubik & Paolo Surico, 2006. "The Lucas critique and the stability of empirical models," Working Paper 06-05, Federal Reserve Bank of Richmond.
  3. Da Silva, Sergio, 2009. "Does Macroeconomics Need Microeconomic Foundations?," Economics Discussion Papers 2009-3, Kiel Institute for the World Economy.
  4. Lombardi, Marco J. & Sgherri, Silvia, 2007. "(Un)naturally low? Sequential Monte Carlo tracking of the US natural interest rate," Working Paper Series 0794, European Central Bank.
  5. Lubik, Thomas A. & Matthes, Christian, 2014. "Indeterminacy and Learning: An Analysis of Monetary Policy in the Great Inflation," Working Paper 14-2, Federal Reserve Bank of Richmond.
  6. Yuelin Liu & James Morley, 2013. "Structural Evolution of the Postwar U.S. Economy," Discussion Papers 2013-15, School of Economics, The University of New South Wales.
  7. Castelnuovo, Efrem & Greco, Luciano & Raggi, Davide, 2008. "Estimating regime-switching Taylor rules with trend inflation," Research Discussion Papers 20/2008, Bank of Finland.
  8. Javier Andrés & Fernando Restoy, 2007. "Macroeconomic modelling in EMU: how relevant is the change in regime?," Banco de Espa�a Working Papers 0718, Banco de Espa�a.
  9. Yash P. Mehra & Devin Reilly, 2009. "Short-term headline-core inflation dynamics," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 289-313.

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