IDEAS home Printed from https://ideas.repec.org/p/spa/wpaper/2017wpecon03.html
   My bibliography  Save this paper

Challenging Lucas: from overlapping generations to infinite-lived agent models

Author

Listed:
  • Michael Assous
  • Pedro Garcia Duarte

Abstract

The canonical history of macroeconomics, one of the rival schools of thought and the great economists, gives Robert Lucas a prominent role in shaping the recent developments in the area. According to it, his followers were initially split into two camps, the “real business cycle” theorists with models of efficient fluctuations, and the “new-Keynesians” with models in which fluctuations are costly, and the government has a role to play, due to departures from the competitive equilibrium (such as nominal rigidities and imperfect competition). Later on, a consensus view emerged (the so-called new neoclassical synthesis), based on the dynamic stochastic general equilibrium (DSGE) model, which combines elements of the models developed by economists of those two groups. However, this account misses critical developments, as already pointed out by Cherrier and Saïdi (2015). As a reaction to Lucas’s 1972 policy ineffectiveness results, based on an overlapping generations (OLG) model, a group of macroeconomists realized that a competitive OLG model may have a continuum of equilibria and that this indeterminacy justified government intervention for competitive cycles that emerged even in deterministic models. We can identify here two distinct, but related, groups: one of the deterministic cycles of David Gale, David Cass, and Jean-Michel Grandmont, and another of the stochastic models and sunspots of Karl Shell, Roger Guesnerie, Roger Farmer and Costas Azariadis (Lucas’s PhD student). Here, the OLG was the workhorse model. Following from these works, a number of authors, including Michael Woodford, argued that similar results could occur in models with infinitely lived agents when there are various kinds of market imperfections. With such generalization, some of these macroeconomists saw that once these imperfections are introduced, nothing important for business cycle modeling was lost and they could therefore leave the OLG model aside as a model of business fluctuations, to the dismay of authors such as Grandmont, Robert Solow and Frank Hahn. In this paper, we scrutinize the differences between the deterministic cycles and sunspot groups and explore the many efforts of building a dynamic competitive business cycle model that implies a role for the government to play. We then assess the transformation process that took place in the late 1980s when several macroeconomists switched from OLG to infinite-lived agents models with imperfections that eventually became central to the DSGE literature. With this we hope to shed more light on the origins of new neoclassical synthesis.

Suggested Citation

  • Michael Assous & Pedro Garcia Duarte, 2017. "Challenging Lucas: from overlapping generations to infinite-lived agent models," Working Papers, Department of Economics 2017_03, University of São Paulo (FEA-USP).
  • Handle: RePEc:spa:wpaper:2017wpecon03
    as

    Download full text from publisher

    File URL: http://www.repec.eae.fea.usp.br/documentos/Assous_Duarte_03WP.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. De Vroey Michel & Duarte Pedro Garcia, 2013. "In search of lost time: the neoclassical synthesis," The B.E. Journal of Macroeconomics, De Gruyter, vol. 13(1), pages 1-31, January.
    2. Farmer, Roger E.A., 2016. "The Evolution Of Endogenous Business Cycles," Macroeconomic Dynamics, Cambridge University Press, vol. 20(2), pages 544-557, March.
    3. Perry Mehrling, 2002. "Don Patinkin and the origins of postwar monetary orthodoxy," The European Journal of the History of Economic Thought, Taylor & Francis Journals, vol. 9(2), pages 161-185.
    4. N. G. Mankiw, 2009. "The Macroeconomist as Scientist and Engineer," Voprosy Ekonomiki, NP Voprosy Ekonomiki, issue 5.
    5. Barro, Robert J, 1974. "Are Government Bonds Net Wealth?," Journal of Political Economy, University of Chicago Press, vol. 82(6), pages 1095-1117, Nov.-Dec..
    6. Kehoe, Timothy J. & Levine, David K., 1984. "Regularity in overlapping generations exchange economies," Journal of Mathematical Economics, Elsevier, vol. 13(1), pages 69-93, April.
    7. Marvin Goodfriend & Robert G. King, 1997. "The New Neoclassical Synthesis and the Role of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 231-296, National Bureau of Economic Research, Inc.
    8. Gale, David, 1973. "Pure exchange equilibrium of dynamic economic models," Journal of Economic Theory, Elsevier, vol. 6(1), pages 12-36, February.
    9. Backhouse,Roger E. & Boianovsky,Mauro, 2014. "Transforming Modern Macroeconomics," Cambridge Books, Cambridge University Press, number 9781107435384.
    10. Paul A. Samuelson, 1958. "An Exact Consumption-Loan Model of Interest with or without the Social Contrivance of Money," Journal of Political Economy, University of Chicago Press, vol. 66(6), pages 467-467.
    11. Black, Fischer, 1974. "Uniqueness of the price level in monetary growth models with rational expectations," Journal of Economic Theory, Elsevier, vol. 7(1), pages 53-65, January.
    12. Grandmont, Jean-Michel, 1985. "On Endogenous Competitive Business Cycles," Econometrica, Econometric Society, vol. 53(5), pages 995-1045, September.
    13. Woodford, Michael, 1994. "Monetary Policy and Price Level Determinacy in a Cash-in-Advance Economy," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 4(3), pages 345-380.
    14. Gali Jordi, 1994. "Monopolistic Competition, Business Cycles, and the Composition of Aggregate Demand," Journal of Economic Theory, Elsevier, vol. 63(1), pages 73-96, June.
    15. Benhabib, Jess & Schmitt-Grohe, Stephanie & Uribe, Martin, 2001. "The Perils of Taylor Rules," Journal of Economic Theory, Elsevier, vol. 96(1-2), pages 40-69, January.
    16. Lucas, Robert E, Jr, 1986. "Adaptive Behavior and Economic Theory," The Journal of Business, University of Chicago Press, vol. 59(4), pages 401-426, October.
    17. Sargent, Thomas J & Wallace, Neil, 1973. "The Stability of Models of Money and Growth with Perfect Foresight," Econometrica, Econometric Society, vol. 41(6), pages 1043-1048, November.
    18. 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.
    19. Cass, David & Shell, Karl, 1983. "Do Sunspots Matter?," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 193-227, April.
    20. Philip Arestis & Alexander Mihailov, 2011. "Classifying Monetary Economics: Fields And Methods From Past To Future," Journal of Economic Surveys, Wiley Blackwell, vol. 25(4), pages 769-800, September.
    21. Farmer, Roger E. A., 1986. "Deficits and cycles," Journal of Economic Theory, Elsevier, vol. 40(1), pages 77-88, October.
    22. Boldrin, Michele & Woodford, Michael, 1990. "Equilibrium models displaying endogenous fluctuations and chaos : A survey," Journal of Monetary Economics, Elsevier, vol. 25(2), pages 189-222, March.
    23. Shiller, Robert J., 1978. "Rational expectations and the dynamic structure of macroeconomic models : A critical review," Journal of Monetary Economics, Elsevier, vol. 4(1), pages 1-44, January.
    24. Lucas, Robert E, Jr & Stokey, Nancy L, 1987. "Money and Interest in a Cash-in-Advance Economy," Econometrica, Econometric Society, vol. 55(3), pages 491-513, May.
    25. Olivier Blanchard, 2000. "What Do We Know about Macroeconomics that Fisher and Wicksell Did Not?," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 115(4), pages 1375-1409.
    26. Olivier Blanchard, 2009. "The State of Macro," Annual Review of Economics, Annual Reviews, vol. 1(1), pages 209-228, May.
    27. Reichlin, Pietro, 1986. "Equilibrium cycles in an overlapping generations economy with production," Journal of Economic Theory, Elsevier, vol. 40(1), pages 89-102, October.
    28. Brock, William A, 1974. "Money and Growth: The Case of Long Run Perfect Foresight," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 15(3), pages 750-777, October.
    29. Grandmont, Jean-Michel & Laroque, Guy, 1986. "Stability of cycles and expectations," Journal of Economic Theory, Elsevier, vol. 40(1), pages 138-151, October.
    30. Rosser, J Barkley, Jr, 1990. "Chaos Theory and the New Keynesian Economics," The Manchester School of Economic & Social Studies, University of Manchester, vol. 58(3), pages 265-291, September.
    31. Lucas, Robert E, Jr, 1975. "An Equilibrium Model of the Business Cycle," Journal of Political Economy, University of Chicago Press, vol. 83(6), pages 1113-1144, December.
    32. Azariadis, Costas, 1981. "Self-fulfilling prophecies," Journal of Economic Theory, Elsevier, vol. 25(3), pages 380-396, December.
    33. Muller, Walter III & Woodford, Michael, 1988. "Determinacy of equilibrium in stationary economies with both finite and infinite lived consumers," Journal of Economic Theory, Elsevier, vol. 46(2), pages 255-290, December.
    34. Fischer, Stanley, 1977. "Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 191-205, February.
    35. Gordon, Robert J, 1990. "What Is New-Keynesian Economics?," Journal of Economic Literature, American Economic Association, vol. 28(3), pages 1115-1171, September.
    36. Prescott, Edward C & Lucas, Robert E, Jr, 1972. "A Note on Price Systems in Infinite Dimensional Space," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 13(2), pages 416-422, June.
    37. Fischer, Stanley, 1975. "Recent Developments in Monetary Theory," American Economic Review, American Economic Association, vol. 65(2), pages 157-166, May.
    38. Brock, W.A., 1990. "Overlapping generations models with money and transactions costs," Handbook of Monetary Economics, in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 1, chapter 7, pages 263-295, Elsevier.
    39. Shell, Karl, 1971. "Notes on the Economics of Infinity," Journal of Political Economy, University of Chicago Press, vol. 79(5), pages 1002-1011, Sept.-Oct.
    40. Benhabib Jess & Rustichini Aldo, 1994. "Introduction to the Symposium on Growth, Fluctuations, and Sunspots: Confronting the Data," Journal of Economic Theory, Elsevier, vol. 63(1), pages 1-18, June.
    41. Blanchard, Olivier J, 1979. "Backward and Forward Solutions for Economies with Rational Expectations," American Economic Review, American Economic Association, vol. 69(2), pages 114-118, May.
    42. repec:fth:harver:1470 is not listed on IDEAS
    43. Pedro Garcia Duarte, 2012. "Not Going Away? Microfoundations in the Making of a New Consensus in Macroeconomics," Chapters, in: Microfoundations Reconsidered, chapter 6, Edward Elgar Publishing.
    44. Mankiw, N Gregory, 1990. "A Quick Refresher Course in Macroeconomics," Journal of Economic Literature, American Economic Association, vol. 28(4), pages 1645-1660, December.
    45. Michael Woodford, 1990. "Self-Fulfilling Expectations and Fluctuations in Aggregate Demand," NBER Working Papers 3361, National Bureau of Economic Research, Inc.
    46. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93.
    47. Michael Woodford, 2009. "Convergence in Macroeconomics: Elements of the New Synthesis," American Economic Journal: Macroeconomics, American Economic Association, vol. 1(1), pages 267-279, January.
    48. Sargent, Thomas J & Wallace, Neil, 1975. ""Rational" Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 83(2), pages 241-254, April.
    49. Miguel Sidrauski, 1967. "Inflation and Economic Growth," Journal of Political Economy, University of Chicago Press, vol. 75(6), pages 796-796.
    50. Farmer Roger E. A. & Guo Jang-Ting, 1994. "Real Business Cycles and the Animal Spirits Hypothesis," Journal of Economic Theory, Elsevier, vol. 63(1), pages 42-72, June.
    51. Black, Fischer, 1972. "Active and Passive Monetary Policy in a Neoclassical Model," Journal of Finance, American Finance Association, vol. 27(4), pages 801-814, September.
    52. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
    53. Grandmont, Jean-Michel, 1986. "Stabilizing competitive business cycles," Journal of Economic Theory, Elsevier, vol. 40(1), pages 57-76, October.
    54. Tirole, Jean, 1985. "Asset Bubbles and Overlapping Generations," Econometrica, Econometric Society, vol. 53(6), pages 1499-1528, November.
    55. Phelps, Edmund S & Taylor, John B, 1977. "Stabilizing Powers of Monetary Policy under Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 163-190, February.
    56. Michael Woodford, 1990. "Equilibrium Models of Endogenous Fluctuations: an Introduction," NBER Working Papers 3360, National Bureau of Economic Research, Inc.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Donato Masciandaro, 2018. "Central Banking and Macroeconomic Ideas: Economics, Politics and History," BAFFI CAREFIN Working Papers 1858, BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Roger E.A. Farmer, 2019. "The Indeterminacy School in Macroeconomics," NBER Working Papers 25879, National Bureau of Economic Research, Inc.
    2. Roger E A Farmer, 2019. "The Indeterminacy Agenda in Macroeconomics," National Institute of Economic and Social Research (NIESR) Discussion Papers 507, National Institute of Economic and Social Research.
    3. Pedro Garcia Duarte, 2012. "Not Going Away? Microfoundations in the Making of a New Consensus in Macroeconomics," Chapters, in: Microfoundations Reconsidered, chapter 6, Edward Elgar Publishing.
    4. Roger Farmer & Pawel Zabczyk, 2019. "The Fiscal Theory of the Price Level in Overlapping Generations Models," National Institute of Economic and Social Research (NIESR) Discussion Papers 498, National Institute of Economic and Social Research.
    5. Roger E.A. Farmer & Pawel Zabczyk, 2019. "Monetary and Fiscal Policy When People Have Finite Lives," NBER Working Papers 25445, National Bureau of Economic Research, Inc.
    6. Pedro Garcia Duarte & Gilberto Tadeu Lima, 2012. "Microfoundations Reconsidered," Books, Edward Elgar Publishing, number 14869.
    7. P Arestis & A Mihailov, 2009. "Flexible Rules cum Constrained Discretion: A New Consensus in Monetary Policy," Economic Issues Journal Articles, Economic Issues, vol. 14(2), pages 27-54, September.
    8. Tomohiro HIRANO & Joseph E. Stiglitz, 2021. "Land Speculation and Wobbly Dynamics with Endogenous Phase Transitions," CIGS Working Paper Series 21-009E, The Canon Institute for Global Studies.
    9. Mr. Roger Farmer & Pawel Zabczyk, 2019. "A Requiem for the Fiscal Theory of the Price Level," IMF Working Papers 2019/219, International Monetary Fund.
    10. Philip Arestis & Alexander Mihailov, 2011. "Classifying Monetary Economics: Fields And Methods From Past To Future," Journal of Economic Surveys, Wiley Blackwell, vol. 25(4), pages 769-800, September.
    11. Guo, Jang-Ting & Lansing, Kevin J., 2002. "Fiscal Policy, Increasing Returns, And Endogenous Fluctuations," Macroeconomic Dynamics, Cambridge University Press, vol. 6(5), pages 633-664, November.
    12. Christiano, Lawrence J. & G. Harrison, Sharon, 1999. "Chaos, sunspots and automatic stabilizers," Journal of Monetary Economics, Elsevier, vol. 44(1), pages 3-31, August.
    13. McCallum, Bennett T., 1983. "On non-uniqueness in rational expectations models : An attempt at perspective," Journal of Monetary Economics, Elsevier, vol. 11(2), pages 139-168.
    14. Etro, Federico, 2017. "Research in economics and macroeconomics," Research in Economics, Elsevier, vol. 71(3), pages 373-383.
    15. Antoine Le Riche & Francesco Magris, 2016. "Decreasing Transaction Costs and Endogenous Fluctuations in a Monetary Model," Economics Bulletin, AccessEcon, vol. 36(4), pages 2381-2393.
    16. Céline Rochon & Herakles Polemarchakis, 2006. "Debt, liquidity and dynamics," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 27(1), pages 179-211, January.
    17. Yuli Radev, 2015. "New dynamic disequilibrium," Economic Thought journal, Bulgarian Academy of Sciences - Economic Research Institute, issue 6, pages 65-90.
    18. Michener, Ronald & Ravikumar, B., 1998. "Chaotic dynamics in a cash-in-advance economy," Journal of Economic Dynamics and Control, Elsevier, vol. 22(7), pages 1117-1137, May.
    19. John Duffy, 2008. "Macroeconomics: A Survey of Laboratory Research," Working Paper 334, Department of Economics, University of Pittsburgh, revised Jun 2014.
    20. Romain Plassard, 2019. "From Disequilibrium to Equilibrium Macroeconomics: Barro and Grossman's Trade-off between Rigor and Realism," GREDEG Working Papers 2019-17, Groupe de REcherche en Droit, Economie, Gestion (GREDEG CNRS), Université Côte d'Azur, France.

    More about this item

    Keywords

    overlapping generations model; Robert Lucas; Michael Woodford; DSGE model; new neoclassical synthesis;
    All these keywords.

    JEL classification:

    • B22 - Schools of Economic Thought and Methodology - - History of Economic Thought since 1925 - - - Macroeconomics
    • B23 - Schools of Economic Thought and Methodology - - History of Economic Thought since 1925 - - - Econometrics; Quantitative and Mathematical Studies
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:spa:wpaper:2017wpecon03. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Pedro Garcia Duarte (email available below). General contact details of provider: https://edirc.repec.org/data/deuspbr.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.