The Nobel Prize

Robert E. Lucas Jr (b. 1937)

Robert Lucas was born in Yakima, Washington, USA in 1937. As an undergraduate he majored in history and received his BA from the University of Chicago in 1959. Lucas began his graduate studies at the University of California at Berkeley before deciding to switch from history to economics and return to the University of Chicago, where he was awarded a PhD in 1964. In 1963 he was appointed assistant professor at Carnegie Institute of Technology (later renamed Carnegie-Mellon University) and was subsequently promoted to associate professor in 1967, and Professor of Economics in 1970. He returned to the University of Chicago in 1974, first as visiting research professor and then as professor in 1975. In 1980 Lucas became the John Dewey Distinguished Service Professor of Economics at Chicago, a post he still holds. Among his offices and honours, Lucas served as the president of each of the Econometric Society in 1997 and the American Economic Association in 2002. In 1995 he was awarded the Nobel Memorial Prize in Economics ‘for having developed and applied the hypothesis of rational expectations, and thereby transformed macroeconomic analysis and deepened our understanding of economic policy’ (Nobel Foundation, 2004).

Lucas is best known for his highly influential work in macroeconomics and is widely acknowledged as being the leading figure in the development of new classical macroeconomics and the associated rational expectations revolution. The analytical foundation of the new classical approach to macroeconomics was established in a series of papers written by Lucas (1972; 1973; 1975; 1977), and other prominent new classicists, including Robert Barro, Finn Kydland (see entry in this volume), Edward Prescott (see entry in this volume), Thomas Sargent and Neil Wallace, during the 1970s. The approach is based on the joint acceptance of three main sub-hypotheses, namely: (i) the rational expectations hypothesis – associated with the work of John Muth in the early 1960s – whereby forwardlooking agents make the best use of all available information, including information on current and prospective policies, to form their expectations; (ii) the assumption that all markets in the economy continuously clear, in line with the Walrasian tradition; and (iii) the Lucas ‘surprise’ aggregate supply hypothesis, whereby output deviates from its natural level only in response to an unexpected (surprise) increase in the price level.

In his path-breaking 1972 Journal of Economic Theory paper, ‘Expectations and the Neutrality of Money’, Lucas combined the natural rate hypothesis, which had been developed independently by Edmund Phelps and Milton Friedman (see entry in this volume) in the late 1960s, with the assumption of continuous market clearing and the hypothesis that economic agents form rational expectations. In doing so, Lucas was able to demonstrate that a rational expectations equilibrium model is compatible with a positive (nonexploitable) short-run trade-off between output and inflation, when agents have imperfect information. Central to this result is the distinction between anticipated and unanticipated changes in the money supply (see, for example, Lucas, 1996). While anticipated monetary shocks are neutral, unanticipated monetary shocks will, in the short run, cause output and employment to deviate from their natural levels when agents with incomplete information misperceive a change in the general price level as a change in relative prices. In his 1973 American Economic Review paper, ‘Some International Evidence on Output–Inflation Tradeoffs’, Lucas was able to reach a much larger audience by producing a more accessible paper compared to his highly formal and mathematically complex 1972 Journal of Economic Theory paper.

In subsequent work, Lucas (1975; 1977) developed an equilibrium theory of the business cycle based on unanticipated monetary shocks. Although the early 1980s witnessed the demise of the monetary ‘surprise’ explanation of the business cycle – in part due to the implausibility of supposed information gaps relating to aggregate price level and money supply data – Lucas’s work paved the way for economists like Finn Kydland and Edward Prescott to develop a second phase of new classical equilibrium theorising, which has come to be known as the real business cycle approach.

One insight of Lucas’s work in this area involves what is popularly known as the ‘Lucas critique’, after his seminal paper in which the critique first appeared. Lucas (1976) argued that traditional (Keynesian-dominated) methods of policy evaluation may be misleading as they fail to take into account the impact of policy on expectations. He attacked the then-established practice of using large-scale macroeconometric models to evaluate the consequences of alternative policy scenarios, since the parameters of such models may change as economic agents adjust their expectations and behaviour when policy changes. The Lucas critique has stimulated a continuing research programme that has sought to develop dynamic, stochastic general equilibrium models with parameters that are independent of a change in policy regime. Overall this body of work (Lucas, 1972; 1973; 1975; 1976; 1977) has had a profound effect on macroeconomic model building and policy analysis since the early 1970s. In the latter case, Lucas’s insights have reinforced traditional arguments in favour of a rules-based framework for macroeconomic policy making. Many of Lucas’s most influential papers on ‘rational expectations’ macroeconomics are drawn together in his 1981 book Studies in Business-Cycle Theory (Lucas, 1981a).

In addition to his highly influential work on macroeconomic modelling and policy evaluation, Lucas has made a number of important contributions to other fields of research, including:

● labour economics (via his 1969 Journal of Political Economy article, co-written with Leonard Rapping, in which – in line with the intertemporal labour substitution hypothesis – changes in employment are explained in terms of the ‘voluntary’ choices of households that change their supply of labour in response to perceived temporary changes in real wages by working more hours when real wages are temporarily high, and vice versa);
● the theory of investment (via his 1971 Econometrica article, ‘Investment Under Uncertainty’, co-written with Edward Prescott);
● the theory of finance (via his 1978 Econometrica article, in which he put forward a general equilibrium model of asset pricing with rational expectations);
● rational expectations econometrics (see, for example, the early contributions to this field of research in the book Rational Expectations and Econometric Practice (Lucas and Sargent, 1981b), which he co-edited with Thomas Sargent);
● monetary theory (via his 1987 ‘cash-in-advance’ Econometrica article, co-written with Nancy Stokey);
● recursive methods in economic dynamics (Lucas et al., 1989, co-written with Nancy Stokey and Edward Prescott); and
● economic growth (for example, via his classic 1988 Journal of Monetary Economics article ‘On the Mechanics of Economic Development’, in which he highlighted the importance of human capital accumulation and learning by doing – Lucas’s work in this area, together with that of Paul Romer, has led to a resurgence of interest in the analysis of economic growth and most notably the development of endogenous growth theory).

The above list is far from exhaustive and merely serves to illustrate the breadth and depth of his seminal contributions to numerous fields of research. Lucas is one of the most influential economic theorists of modern times, whose pioneering work, most notably in the 1970s, has transformed macroeconomics.

Main Published Works
(1969), ‘Real Wages, Employment and Inflation’ (with L.A. Rapping), Journal of Political Economy, 77, September/October, pp. 721–54.
(1971), ‘Investment Under Uncertainty’ (with E.C. Prescott), Econometrica, 39, September, pp. 659–81.
(1972), ‘Expectations and the Neutrality of Money’, Journal of Economic Theory, 4, April, pp. 103–24.
(1973), ‘Some International Evidence on Output–Inflation Tradeoffs’, American Economic Review, 63, June, pp. 326–34.
(1975), ‘An Equilibrium Model of the Business Cycle’, Journal of Political Economy, 83, December, pp. 1113–44.
(1976), ‘Econometric Policy Evaluation: A Critique’, in K. Brunner and A.H. Meltzer (eds), The Phillips Curve and Labour Markets, Amsterdam: North-Holland, pp. 19–46.
(1977), ‘Understanding Business Cycles’, in K. Brunner and A.H. Meltzer (eds), Stabilization of the Domestic and International Economy, Carnegie-Rochester Conference Series on Public Policy, 5, Amsterdam: North-Holland, pp. 7–29.
(1978), ‘Asset Prices in an Exchange Economy’, Econometrica, 46, November, pp. 1429–45.
(1981a), Studies in Business-Cycle Theory, Oxford: Basil Blackwell. (1981b), Rational Expectations and Econometric Practice (ed. with T.J. Sargent), Minneapolis, MN: University of Minnesota Press.
(1987), ‘Money and Interest in a Cash-in-Advance Economy’ (with N.L. Stokey), Econometrica, 55, May, pp. 491–514.
(1988), ‘On the Mechanics of Economic Development’, Journal of Monetary Economics, 22, July, pp. 3–42.
(1989), Recursive Methods in Economic Dynamics (with N.L. Stokey and E.C. Prescott), Cambridge, MA: Harvard University Press.
(1996), ‘Nobel Lecture: Monetary Neutrality’, Journal of Political Economy, 104, August, pp. 661– 82.

Secondary Literature
Chari, V.V. (1998), ‘Nobel Laureate Robert E. Lucas, Jr.: Architect of Modern Macroeconomics’, Journal of Economic Perspectives, 12, Winter, pp. 171–86.
Fischer, S. (1996), ‘Robert Lucas’s Nobel Memorial Prize’, Scandinavian Journal of Economics, 98, March, pp. 11–31.
Hall, R.E. (1996), ‘Robert Lucas, Recipient of the 1995 Nobel Memorial Prize in Economics’, Scandinavian Journal of Economics, 98, March, pp. 33–48.
Hoover, K.D. (ed.) (1999), The Legacy of Robert Lucas Jr., Cheltenham, UK and Northampton, MA, USA: Edward Elgar.
Snowdon, B. and H.R. Vane (1998), ‘Transforming Macroeconomics: An Interview with Robert E. Lucas Jr.’, Journal of Economic Methodology, 5, June, pp. 115–46.
Svensson, L.E.O. (1996), ‘The Scientific Contributions of Robert E. Lucas, Jr.’, Scandinavian Journal of Economics, 98, March, pp. 1–10.
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