Adaptive expectations, underparameterization and the Lucas critique

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    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 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. (c) 2005 Elsevier B.V. All rights reserved.

    Original languageEnglish
    Pages (from-to)249-264
    Number of pages16
    JournalJournal of Monetary Economics
    Volume53
    Issue number2
    DOIs
    Publication statusPublished - Mar 2006

    Keywords

    • Lucas critique
    • expectations
    • underparameterization
    • bounded rationality
    • learning
    • MONEY SUPPLY RULE
    • RATIONAL-EXPECTATIONS

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