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Mitigation of the Lucas critique with stochastic control methods

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Listed author(s):
  • 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.

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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 27 (2003)
Issue (Month): 11 ()
Pages: 2035-2057

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Handle: RePEc:eee:dyncon:v:27:y:2003:i:11:p:2035-2057
DOI: 10.1016/S0165-1889(02)00115-X
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

Keywords: Macroeconomics; Rational expectations; Stochastic optimization; Numerical experiments;

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Find related papers by 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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  1. 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.
  2. M. R. Wickens, 1982. "The Efficient Estimation of Econometric Models with Rational Expectations," Review of Economic Studies, Oxford University Press, vol. 49(1), pages 55-67.
  3. David Andolfatto & Paul Gomme, 2003. "Monetary Policy Regimes and Beliefs," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 44(1), pages 1-30, February.
  4. Wallis, Kenneth F, 1980. "Econometric Implications of the Rational Expectations Hypothesis," Econometrica, Econometric Society, vol. 48(1), pages 49-73, January.
  5. 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.
  6. Robert E. Lucas, Jr. & Thomas J. Sargent, 1979. "After Keynesian macroeconomics," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Spr.
  7. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-1311, July.
  8. Amman, Hans M. & Neudecker, Heinz, 1997. "Numerical solutions of the algebraic matrix Riccati equation," Journal of Economic Dynamics and Control, Elsevier, vol. 21(2-3), pages 363-369.
  9. Amman, Hans & Kendrick, David, 1999. "Linear-Quadratic Optimization For Models With Rational Expectations," Macroeconomic Dynamics, Cambridge University Press, vol. 3(04), pages 534-543, December.
  10. Tucci, Marco P., 1997. "Adaptive control in the presence of time-varying parameters," Journal of Economic Dynamics and Control, Elsevier, vol. 22(1), pages 39-47, November.
  11. Benhabib, Jess & Farmer, Roger E.A., 1999. "Indeterminacy and sunspots in macroeconomics," Handbook of Macroeconomics,in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 6, pages 387-448 Elsevier.
  12. 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.
  13. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
  14. 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.
  15. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
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Cited by:

  1. repec:use:tkiwps:2020 is not listed on IDEAS
  2. 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.
  3. 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.
  4. 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.
  5. Halkos, George & Tsilika, Kyriaki, 2016. "Climate change impacts: Understanding the synergetic interactions using graph computing," MPRA Paper 75037, University Library of Munich, Germany.
  6. 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.
  7. Athanasiou, George & Kotsios, Stelios, 2008. "An algorithmic approach to exchange rate stabilization," Economic Modelling, Elsevier, vol. 25(6), pages 1246-1260, November.

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