Rereading Lucas In Addition To Sargent 1979

Mainly for macroeconomists too those interested inwards macroeconomic thought

Following this footling interchange ( Paul Krugman,me, Paul Krugman, Paul Krugman,Mark Thoma, Paul Krugman, Paul Krugman,Noah Smith, Paul Krugman, Paul Krugman,Robert Waldman, Arnold Kling), I reread what could live on regarded equally the New Classical manifesto: Lucas too Sargent’s ‘After Keynesian Economics’ (hereafter LS). It deserves to live on cited equally a classic, both for the lineament of ideas too the persuasiveness of the writing. It does non seem similar something written 35 ago, which is maybe an indication of how influential its ideas all the same are.

What I desire to explore is whether this manifesto for the New Classical counter revolution was mainly close stagflation, or whether it was mainly close methodology. LS kicking off their article alongside references to stagflation too the failure of Keynesian theory. Influenza A virus subtype H5N1 key rethink is required. What follows side past times side is I intend crucial. If the counter revolution is all close stagflation, nosotros powerfulness facial expression an describe concern human relationship of why conventional theory failed to predict stagflation - the equivalent, perhaps, to the give-and-take of classical theory inwards the General Theory. Instead nosotros larn something much to a greater extent than full general - a give-and-take of why identification restrictions typically imposed inwards the structural econometric models (SEMs) of the fourth dimension are incredible from a theoretical signal of view, too an outline of the Lucas critique.

In other words, the essential criticism inwards LS is methodological: the agency empirical macroeconomics has been done since Keynes is flawed. SEMs cannot live on trusted equally a guide for policy. In alone 1 paragraph practise LS essay to link this full general critique to stagflation:

“Though not, of course, designed equally such past times anyone, macroeconometric models were subjected to a decisive essay inwards the 1970s. Influenza A virus subtype H5N1 key chemical constituent inwards all Keynesian models is a trade-off betwixt inflation too existent output: the higher is the inflation rate, the higher is output (or equivalently, the lower is the charge per unit of measurement of unemployment). For example, the models of the like shooting fish in a barrel 1960s predicted a sustained U.S. of A. unemployment charge per unit of measurement of 4% equally consistent alongside a 4% annual charge per unit of measurement of inflation. Based on this prediction, many economists at that fourth dimension urged a deliberate policy of inflation. Certainly the erratic ‘fits too starts’ grapheme of actual U.S. of A. policy inwards the 1970s cannot live on attributed to recommendations based on Keynesian models, simply the inflationary bias on average of monetary too financial policy inwards this catamenia should, according to all of these models, bring produced the lowest unemployment rates for whatever decade since the 1940s. In fact, equally nosotros know, they produced the highest unemployment rates since the 1930s. This was econometric failure on a grand scale.”

There is no drive to link this stagflation failure to the identification problems discussed earlier. Indeed, they become on to tell that they recognise that item empirical failures (by inference, similar stagflation) powerfulness live on solved past times changes to item equations inside SEMs. Of class that is exactly what mainstream macroeconomics was doing at the time, alongside the expectations augmented Phillips curve.

In the schema due to Lakatos, a failing mainstream theory may all the same live on able to explicate previously anomalous results, simply alone inwards such a contrived agency that it makes the programme degenerate. Yet, equally Jesse Zinn argues inwards this paper, the changes to the Phillips plication suggested past times Friedman too Phelps seem progressive rather than degenerate. True, this invention came from thinking close microeconomic theory, simply innovations inwards SEMs had e'er come upward from a mixture of microeconomic theory too evidence. 

This is why LS become on to say: “We bring couched our criticisms inwards such full general damage just to emphasise their generic grapheme too thus the futility of pursuing kid variations inside this full general framework.” The residual of the article is close how, given additions similar a Lucas provide curve, classical ‘equilibrium’ analysis may live on able to explicate the ‘facts’ close output too unemployment that Keynes thought classical economic science was incapable of doing. It is non close how these models are, or fifty-fifty powerfulness be, ameliorate able to explicate the item job of stagflation than SEMs.

In their conclusion, LS summarise their argument. They say:

“First, too most important, existing Keynesian macroeconometric models are incapable of providing reliable guidance inwards formulating monetary, financial too other types of policy. This determination is based inwards purpose on the spectacular recent failures of these models, too inwards purpose on their lack of a audio theoretical or econometric basis.”

Reading the newspaper equally a whole, I intend it would live on fair to tell that these 2 parts were non equal. The focus of the newspaper is close the lack of a audio theoretical or econometric dry soil for SEMs, rather than the failure to predict or explicate stagflation. As I volition debate inwards a subsequent post, it was this methodological critique, rather than whatever superior empirical ability, that led to the success of this manifesto.