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Robust Decision Theory and the Lucas Critique

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  • Mark Salmon
  • Massimiliano Marcellino

Abstract

In this paper, we reconsider the theoretical basis for the Lucas critique from the point of view of robust decision theory. We first emphasize that the Lucas critique rests on a weak theoretical paradigm in that it fails to consider the motivation for the policy change by the government and hence inconsistently assumes limited rationality by the government. When placed in a proper dynamic general equilibrium framework of a dynamic game between the government and the private sector, much of the force of the critique simply vanishes. We also reconsider the critique by adopting an alternative theoretical paradigm and notion of rationality based on robust decision theory. This view of rationality might be regarded as more relevant than the nonrobust rationality employed by Lucas and, critically, it is one in which the Lucas critique can be shown simply not to apply, provided the private sector has adopted suitably robust decision rules.

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Bibliographic Info

Paper provided by Warwick Business School, Finance Group in its series Working Papers with number wp01-10.

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Date of creation: 2001
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Handle: RePEc:wbs:wpaper:wp01-10

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Cited by:
  1. Arnulfo Rodríguez & Fidel González & Jesús R. González García, 2007. "Uncertainty about the Persistence of Cost-Push Shocks and the Optimal Reaction of the Monetary Authority," Working Papers 2007-05, Banco de México.
  2. Brock,W.A. & Durlauf,S.N., 2004. "Macroeconomics and model uncertainty," Working papers 20, Wisconsin Madison - Social Systems.
  3. Brock,W.A. & Durlauf,S.N. & West,K.D., 2004. "Model uncertainty and policy evaluation : some theory and empirics," Working papers 19, Wisconsin Madison - Social Systems.
  4. Brock,W.A. & Durlauf,S.N., 2003. "Elements of a theory of design limits to optimal policy," Working papers 25, Wisconsin Madison - Social Systems.
  5. Gonzalez F. & Rodriguez A. & Gonzalez-Garcia J.R., 2005. "Uncertainty about the Persistence of Periods with Large Price Shocks and the Optimal Reaction of the Monetary Authority," Computing in Economics and Finance 2005 402, Society for Computational Economics.
  6. Kasa, Kenneth, 2002. "Model Uncertainty, Robust Policies, And The Value Of Commitment," Macroeconomic Dynamics, Cambridge University Press, vol. 6(01), pages 145-166, February.
  7. Pataracchia, B., 2011. "Ambiguity and Volatility: Asset Pricing Implications," Discussion Paper 2011-042, Tilburg University, Center for Economic Research.
  8. Brock,W.A. & Durlauf,S.N., 2004. "Local robustness analysis : theory and application," Working papers 22, Wisconsin Madison - Social Systems.
  9. Gerlach-Kristen, Petra, 2006. "Internal and external shocks in Hong Kong: Empirical evidence and policy options," Economic Modelling, Elsevier, vol. 23(1), pages 56-75, January.

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