Lucas's Early Research and the Natural Rate of Unemployment

This paper builds a narrative on the early work of Robert E. Lucas Jr., in the late 1960’s, which culminated in the modeling and testing of the natural rate of unemployment hypothesis. Lucas’s modeling and testing of the natural rate can be found, respectively, in two papers: “Expectations and the Neutrality of Money” (Lucas, 1972a) and “Econometric Testing of the Natural Rate Hypothesis” (Lucas, 1972b). These papers are the synthesis of the two branches of Lucas’s research at that time; one on labor market behavior and other on optimal investment by firms. This synthesis changed the way in which the natural rate of unemployment was originally elaborated by Friedman (1968a) and Phelps (1967, 1968), by modeling it in a general equilibrium framework with rational expectations and giving it a proper test. Lucas’s research agenda synthesis in the late 1960’s was the result of his close interaction with Phelps and Prescott, backed up by his pragmatic equilibrium approach to economics, concerning modeling, econometric estimation and testing. Phelps explicitly suggested a general equilibrium approach to Lucas’s labor market modeling, while Prescott helped him in dealing with the rational expectations hypothesis.