Robert Lucas | The Economist who defied expectations

Robert Lucas (Image: https://news.uchicago.edu/)

Robert E. Lucas Jr., a Nobel laureate and one of the world’s greatest economists, has died at the age of 85. Perhaps more than any of his peers, he made modern macroeconomic theory both more rigorous and more useful.

The University of Chicago economics department might have faded into normalcy after the retirement of Milton Friedman in 1977. But Lucas, along with Gary Becker, ensured that a distinctive “Chicago school” would reign for decades to come. Lucas pioneered the doctrine of “rational expectations,” an idea that became central to macroeconomics.

The practical implications of this work are why both the US Federal Reserve and the US Treasury are obsessed with how the markets think about what will happen next. As it turns out, decades of experience with a 2% rate of inflation don’t say much about what will happen in a setting with a rate of 5%. Another implication is that if you want to fix high rates of inflation, you need to investigate expectations of future fiscal deficits, as high deficits might end up being monetized.

As with most true greats, Lucas changed the way economists think. Pre-Lucasian macroeconomic thought was full of hand-waving assumptions about expectations — or did not model expectations at all, assuming that policymakers could operate by optimizing against a fixed background of assumptions about individual behavior. Models were rarely checked for consistency. Most macroeconomics before the mid-1970s, including the work of Milton Friedman and Paul Samuelson, was pre-Lucasian.

Lucas’s primary contribution was to insist that all assumptions about expectations be spelled out and tested to see if they were consistent with all other parts of the argument. For instance, if you wanted to assert that people would respond to one set of government actions but not another, you had to outline why that might be the case. In retrospect it seems simple, but Lucas (with co-authors, notably Nancy Stokey) was the person who showed how to do it. The end result was a reworking of virtually everyone’s macroeconomic arguments — monetarist, Keynesian or otherwise.

The “Lucas critique” showed that policy changes alter how people behave, and thus affect the operation of the economy. Policy, in other words, should not be thought of as manipulating a fixed target: There is always an economic response to any policy, and so doing good macroeconomics is harder than previously thought.

This is a message that rings especially true in the spring of 2023.

Critics sometimes read Lucas as insisting that expectations in the real world are rational — that they accurately predict what will happen, at least on average. That is a misreading of a man who had “an obsessive drive to learn and understand,” in the words of economist Luis Garicano. Lucas is better understood as insisting on the need to identify which bad outcomes result from destructive policies, and which result from mistaken predictions. He wanted the workings of a model to be as legible as possible.

Lucas sometimes was painted as a neoliberal dogmatist, but he was a man who could be persuaded by an argument — and a model. In 2008, he famously declared: “I guess everyone’s a Keynesian in a foxhole.”

Lucas’s most cited paper helped to turn the attention of the economics profession to the topic of economic growth. Therein lies my favorite Lucas quotation:

Is there some action a government of India could take that would lead the Indian economy to grow like Indonesia’s or Egypt’s? If so, what, exactly? If not, what is it about the nature of India that makes it so? The consequences for human welfare involved in questions like these are simply staggering: Once one starts to think about them, it is hard to think about anything else.

To read a Lucas paper was to know that everything in it had been thought through, and very deeply.

I recall Lucas giving a seminar at Harvard in 1984, during my graduate studies there. With his no-nonsense manner and dark suit, he reminded me of a character from a Chicago gangster movie. Yet he was also charming, in part because he could see so quickly where every argument or critical point was headed. Many of the graduate students showed up with a hostile attitude, protective of their more Keynesian approaches and convinced they could expose the simplistic assumptions of Lucas’s models. Ninety minutes later, it was clear that those assumptions were not so vulnerable after all.

Lucas survived that encounter unscathed, and perhaps made a few converts too. He will be missed, but his ideas and arguments will continue to thrive.