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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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Suggested Citation

  • Evans, George W. & Ramey, Garey, 2006. "Adaptive expectations, underparameterization and the Lucas critique," Journal of Monetary Economics, Elsevier, vol. 53(2), pages 249-264, March.
    • Handle: RePEc:eee:moneco:v:53:y:2006:i:2:p:249-264
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    More about this item

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations

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