Wednesday, November 28, 2012

Interview with Robert Lucas

Noah Smith and Steve Williamson point us to this interview with the famous macroeconomist.

Lucas is not the straw man he's sometimes made out to be.

My favorite bits:

"But the term "Lucas critique" has survived, long after that original context has disappeared. It has a life of its own and means different things to different people. Sometimes it is used like a cross you are supposed to use to hold off vampires: Just waving it it an opponent defeats him. Too much of this, no matter what side you are on, becomes just name calling."

Defending New Keynesian models?

If we accept any version of the Quantity Theory of Money then it seems clear that it does not hold at high frequencies (which is what I think price stickiness means). If we don't accept the Quantity Theory of Money at low frequencies then I guess we should just close up shop. There are some hard unresolved problems to be faced.

Causes of business cycles. This is the first time I've heard any macroeconomist say this explicitly, but it is also my view:

I drew from this the idea that all cycles are probably driven the same kind of shocks. Since I was convinced by Friedman and Schwartz that the 1929-33 down turn was induced by monetary factors (declined is money and velocity both) I concluded that a good starting point for theory would be the working hypothesis that all depressions are mainly monetary in origin.

Ed Prescott was skeptical about this strategy from the beginning...He also thought we needed to have some kind of benchmark theoretical model to give us a start...

As I have written elsewhere, I now believe that the evidence on post-war recessions (up to but not including the one we are now in) overwhelmingly supports the dominant importance of real shocks. But I remain convinced of the importance of financial shocks in the 1930s and the years after 2008. Of course, this means I have to renounce the view that business cycles are all alike!

This is beautiful.

Q: If the economy is currently in an unusual state, do micro-foundations still have a role to play?

Lucas: "Micro-foundations"? We know we can write down internally consistent equilibrium models where people have risk aversion parameters of 200 or where a 20% decrease in the monetary base results in a 20% decline in all prices and has no other effects. The "foundations" of these models don't guarantee empirical success or policy usefulness.

What is important---and this is straight out of Kydland and Prescott---is that if a model is formulated so that its parameters are economically-interpretable they will have implications for many different data sets... This kind of cross-validation (or invalidation!) is only possible with models that have clear underlying economics: micro-foundations...This is bread-and-butter stuff in the hard sciences. You try to estimate a given parameter in as many ways as you can..."Unusual state"? Is that what we call it when our favorite models don't deliver what we had hoped? I would call that our usual state.

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