Robert Emerson Lucas was born in 1937, the same year his father’s small business was wiped out by the Great Depression.

In his autobiographical notes for the committee of the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, that honoured him in 1995, Lucas highlights the supportive role of his parents in his outstanding intellectual development (see also Lucas 2001).

Young Robert showed an early interest and talent in science, mathematics, and engineering. After graduating in Seattle, he received a scholarship from the University of Chicago in 1955. There, he was attracted to liberal arts courses, especially to those on Western History. He soon realized, however, that economic education is a prerequisite for good historical judgement. He found his way to economics through Paul Samuelson’s Foundations of Economic Analysis (1947). Lucas owes his enthusiasm for mathematical economics in general, and general equilibrium analysis in particular, to Samuelson. His first contact with macroeconomics in terms of simple investment saving-liquidity preference money supply equilibrium (IS-LM) dynamics left him unimpressed (see Lucas 2004).

It is hard to overestimate the impact of Robert Lucas on modern macroeconomics. To him more than to anyone else does the representative macroeconomist owe his methodological judgement, his toolset, and his theoretical point of view. Lucas enters macroeconomics through the back door, by way of his collaboration with Leonard Rapping on labour economics. In Real Wages, Employment, and Inflation (1969) they apply the notion of intertemporal optimization, a cornerstone of general equilibrium analysis since Irving Fisher, to the labour supply function. They thereby provide a rigorous (Walrasian) foundation for Milton Friedman’s permanent income hypothesis.

Although still endowed with adaptive expectations, otherwise rational households choose between opportunities to allocate their labour supply over time.

For instance, given sufficiently convex preferences, an expected productivity hike suggests a reduction in today’s labour supply. Whereas macroeconomics before Lucas was focused on involuntary unemployment such that employed labour was unidirectionally determined by aggregate demand, macroeconomics since Lucas places great emphasis on voluntarily induced changes in labour supply. Today, the inconvenience to explain empirical variations in labour supply in terms of shifting preferences and expectations is overcome by the introduction of market frictions, accounted for by costly search and matching processes. It is this versatility of his micro-founded toolset that accounts for the productivity of Lucas’s research programme.

Lucas’s possibly most important contributions are “Expectations and the neutrality of money” (1972) and its extension to “An equilibrium model of the business cycle” (1975). He merges his earlier contribution with John F. Muth’s notion of rational expectations in a stochastic general equilibrium setting. The information sets of intertemporally optimizing agents are augmented by a generally understood and accepted macroeconomic model and the “true” probability distributions of the variables specified by the model. Exploiting all such knowledge, agents optimally forecast future equilibrium values such that remaining errors are “white noise”. Labour hours and aggregate output remain unaffected by observed nominal values and money is always and by necessity ineffective and neutral.

Such is the equilibrium benchmark. The music comes from the frictions that Lucas

imposes on his agents. They are locally dispersed and in effect isolated so that they have no access to real-time price-level data. Assuming that transmission is immediate, he shows that if agents also lack knowledge of actual money supply, they have to rely on past data to forecast the ruling price level and thereby to isolate changes in relative prices. If policy exploits this little window to surprise the market, agents face a signalextracting problem since the reliance on all but the present nominal data generates inefficient predictions of their actual values.

To the extent that agents make mistakes that could be avoided by augmenting the information set, real macroeconomic variables deviate from their rational expectations equilibrium values. Thus, a real friction accounts for monetary short-run non-neutrality.

The significance of Lucas’s island model is that it does not rely on the representative agent, a concept that cannot withstand theoretical scrutiny and that nevertheless has become a standard assumption in applied macroeconomics. On the contrary, Lucas makes use of the Walrasian apparatus and the decentralization properties of competitive equilibria. In fact, he makes a subtle distinction between private and public information. Only the latter is the subject-matter of optimal forecasts, imposing already high individual information-processing capabilities.

The alternative would be to extend the notion of rational expectations to the forecast of private information. We know from general equilibrium analysis that such a rational expectations equilibrium is the only permissible alternative to the complete-markets economy. If markets are missing and, therefore, price systems are incomplete, then general equilibrium exists only if each agent is globally informed. Whereas the goal of Walrasian analysis is to conceptualize the coordination of only locally informed agents, which thus places emphasis on the intelligence and information-processing capabilities of the system rather than on individuals, rational expectations with respect to private information suggest superhuman skills and downgrade the anonymous system. Because Lucas avoids this assumption, the decentralization properties of price systems remain intact in his framework.

However, even if rational expectations only extend to public information, it is still overly restrictive. It needs Friedman’s instrumentalist viewpoint, also adhered to by Lucas, to remain unimpressed by the information-processing capabilities still imposed on each agent.

Even worse, as Roman Frydman (1983) has shown, there is nothing that could ever decentralize the computation of macroeconomic variables. In particular, rational expectations equilibria cannot be learned in a Walrasian setting. The information additionally required to ensure convergence in such disequilibrium processes is that agents have access to other agents’ aggregate forecast functions and average opinions. Certainly, asking for agents that do know each other strictly violates Walrasian standards.

From a purely theoretical perspective, the alliance of rational expectations and general equilibrium analysis is no success. So Lucas’s toolset is certainly less restrictive than the “new Keynesian” workhorse, that is, the class of representative-agent-based real business cycle models equipped with nominal rigidities, which substitute for the real frictions in Lucas’s semi-decentralized model.

More important for the evaluation of his contributions, however, are the conclusions he draws for empirical analysis and which culminate into the so-called “Lucas critique”. In “Econometric policy evaluation - a critique” (1976), Lucas formulates his opposition to the then ruling econometric practices, especially with regard to their ability to record market adjustments to shifts in policy regimes. Without microfoundations, so his argument goes, it is impossible to isolate changes in data owing to policy shifts from changes owing to shifts of primitive or “deep” data. It follows that forecasts of the then dominant models systematically fail whenever they are specified for time series that have memorized some policy regime and are applied to periods with another regime. The Lucas critique led to radical adjustments of all those economists, who believed in structural models in empirical analysis. It may be owing to the dominance of applied work that Lucas’s research programme still dominates macroeconomics. He has developed the tools and has shown how to apply them in his many empirical contributions.

He thereby unequivocally improved the practice of doing macroeconomics.

From a pure theory perspective, however, his impressive contribution still fails. Either it is not permissible by his own Walrasian standards or it suffers from the same negative results that struck down the even more impressive contributions to general equilibrium theory associated in the Cowles Commission.

Arash Molavi Vassei and Peter Spahn

Robert Emerson Lucas was born in 1937, the same year his father’s small business was wiped out by the Great Depression.

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