The Lucas critique and the stability of empirical models
Journal
Journal of Applied Econometrics
Subject
Economics
Publishing details
Authors / Editors
Surico P; Lubik T
Biographies
Publication Year
2010
Abstract
This paper reconsiders the empirical relevance of the Lucas critique using a DSGE sticky price model in which a weak central bank response to inflation generates equilibrium indeterminacy. The model is calibrated to capture the magnitude of the historical shift in the Federal Reserve's policy rule. Using Monte Carlo simulations and a backward-looking model of aggregate supply and demand, we find that shifts in the policy rule induce breaks in both the reduced-form coefficients and the reduced-form error variances. When the instability of the reduced-form error variances is accounted for, the Lucas critique is found to be empirically relevant. Copyright © 2009 John Wiley & Sons, Ltd.
Available on ECCH
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