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Mitigation of the Lucas critique with stochastic control methods

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  • Amman, Hans M.
  • Kendrick, David A.

Abstract

Lucas (In: Brunner, K., Meltzer, A.H. (Eds.), The Phillips Curve and the Labor Markets, Supplementary Series to the Journal of Monetary Economics, 1976, pp. 19–46) pointed out, that when optimization is performed on a deterministic macro model, the resulting policy may not reflect the true optimal solution. Private agents may react to announced policies and consequently model parameters will start to drift. The aim of this paper is to develop a methodology for deriving an optimal policy in the presence of rational expectations and parameter drift. This drift is captured by a stochastic optimization framework with time-varying parameters. The resulting optimal policy is capable of tracking changes in the parameters due to policy changes. A numerical example illustrates how the methodology provides a way to mitigate the effects of the Lucas critique.

Suggested Citation

  • Amman, Hans M. & Kendrick, David A., 2003. "Mitigation of the Lucas critique with stochastic control methods," Journal of Economic Dynamics and Control, Elsevier, vol. 27(11), pages 2035-2057.
    • Handle: RePEc:eee:dyncon:v:27:y:2003:i:11:p:2035-2057
    DOI: 10.1016/S0165-1889(02)00115-X
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    References listed on IDEAS

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    2. Amman, Hans M. & Kendrick, David A., 1998. "Computing the steady state of linear quadratic optimization models with rational expectations," Economics Letters, Elsevier, vol. 58(2), pages 185-191, February.
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    5. Wallis, Kenneth F, 1980. "Econometric Implications of the Rational Expectations Hypothesis," Econometrica, Econometric Society, vol. 48(1), pages 49-73, January.
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    7. Swamy, P. A. V. B. & Tinsley, P. A., 1980. "Linear prediction and estimation methods for regression models with stationary stochastic coefficients," Journal of Econometrics, Elsevier, vol. 12(2), pages 103-142, February.
    8. Robert E. Lucas, Jr. & Thomas J. Sargent, 1979. "After Keynesian macroeconomics," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Spr.
    9. Volker Wieland & Andrew Levin & John C. Williams, 1999. "The Performance of Forward-Looking Monetary Policy Rules under Model Uncertainty," Computing in Economics and Finance 1999 1153, Society for Computational Economics.
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    11. Martin Feldstein & James H. Stock, 1994. "The Use of a Monetary Aggregate to Target Nominal GDP," NBER Chapters,in: Monetary Policy, pages 7-69 National Bureau of Economic Research, Inc.
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    1. repec:use:tkiwps:2020 is not listed on IDEAS
    2. Halkos, George E. & Tsilika, Kyriaki D., 2017. "Climate change effects and their interactions: An analysis aiming at policy implications," Economic Analysis and Policy, Elsevier, vol. 53(C), pages 140-146.
    3. Stephen J. Turnovsky, 2011. "Stabilization Theory and Policy: 50 Years after the Phillips Curve," Economica, London School of Economics and Political Science, vol. 78(309), pages 67-88, January.
    4. D.A. Kendrick & H.M. Amman & M.P. Tucci, 2008. "Learning About Learning in Dynamic Economic Models," Working Papers 08-20, Utrecht School of Economics.
    5. David Kendrick & George Shoukry, 2014. "Quarterly Fiscal Policy Experiments with a Multiplier-Accelerator Model," Computational Economics, Springer;Society for Computational Economics, vol. 44(3), pages 269-293, October.
    6. Halkos, George & Tsilika, Kyriaki, 2016. "Climate change impacts: Understanding the synergetic interactions using graph computing," MPRA Paper 75037, University Library of Munich, Germany.
    7. H.M. Amman & D.A. Kendrick, 2012. "Conjectures on the policy function in the presence of optimal experimentation," Working Papers 12-09, Utrecht School of Economics.
    8. Athanasiou, George & Kotsios, Stelios, 2008. "An algorithmic approach to exchange rate stabilization," Economic Modelling, Elsevier, vol. 25(6), pages 1246-1260, November.

    More about this item

    Keywords

    Macroeconomics; Rational expectations; Stochastic optimization; Numerical experiments;

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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