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The Lucas critique and the stability of empirical models
Author(s) -
Lubik Thomas A.,
Surico Paolo
Publication year - 2010
Publication title -
journal of applied econometrics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 2.878
H-Index - 99
eISSN - 1099-1255
pISSN - 0883-7252
DOI - 10.1002/jae.1129
Subject(s) - economics , dynamic stochastic general equilibrium , indeterminacy (philosophy) , inflation (cosmology) , econometrics , stability (learning theory) , lucas critique , taylor rule , keynesian economics , mathematical economics , aggregate (composite) , monetary policy , central bank , computer science , physics , materials science , quantum mechanics , machine learning , theoretical physics , composite material
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.