Answer to Question #54356 in Microeconomics for anu

Question

lucus' point of view, what are the limitation of the keynesian model? What improvements does he suggest?

Answer 1

In the 1970s, Robert Lucas perceived that there was a big problem in macroeconomics. 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".