Answer to Question #50541 in Macroeconomics for nidhi

Question

Lucas’ point of view, what are the limitations of the Keynesian model? What improvements does he suggest?

Answer 1

In the 1970s, Robert Lucas perceived that there was a big problem inmacroeconomics. Models that didn't allow for human beings to adjust their
behavior couldn't be used for policy, because if you tried to use them, people
would alter their behavior until the models no longer worked. This is known as
the "Lucas Critique". The solution, Lucas said, was to explicitly
model the behavior of human beings, and to only use macro models that took this
behavior into account. This is called the "microfoundations"
approach. The first research program that came along and tried to answer the
Lucas Critique was the "Real Business Cycle" program. This program,
spearheaded by researchers such as Ed Prescott, made use of a new modeling
approach called "DSGE". It also incorporated Robert Lucas'
"Rational Expectations Hypothesis".