Snowdon & Vane Modern Macroeconomics

ROBERT E. LUCAS JR

Permission to reprint from the University of

Chicago

Credit: Lloyd De Grane

Robert Lucas was born in 1937 in Yakima, Washington and obtained his BA (History) and PhD from the University of Chicago in 1959 and 1964 respectively. He was a lecturer at the University of Chicago (1962–3), Assistant Professor (1963–7), Associate Professor (1967–70) and Professor of Economics (1970–74) at Carnegie-Mellon University, Ford Foundation Visiting Research Professor (1974–5) and Professor (1975–80) at the University of Chicago. Since 1980 he has been John Dewey Distinguished Service Professor of Economics at the University of Chicago.

Best known for his equilibrium approach to macroeconomic analysis, and his application of rational expectations to the analysis of macroeconomic policy, Robert Lucas is widely acknowledged as being the leading figure in the development of new classical macroeconomics. In addition to his highly influential work on macroeconomic modelling and policy evaluation, he has made a number of important contributions to other research fields including, more recently, economic growth. In 1995 he was awarded the Nobel Memorial Prize in Economics: ‘For having developed and applied the hypothesis of rational expectations, and thereby having transformed macroeconomic analysis and deepened our understanding of economic policy’.

Among his best-known books are: Studies in Business Cycle Theory (Basil Blackwell, 1981); Rational Expectations and Econometric Practice (University of Minnesota Press, 1981), co-edited with Thomas Sargent; Models of

Business Cycles (Basil Blackwell, 1987); Recursive Methods in Economic Dynamics (Harvard University Press, 1989), co-authored with Nancy Stokey and Edward Prescott; and Lectures on Economic Growth (Harvard University Press, 2002).

Among the numerous articles he has written, the best-known include: ‘Expectations and the Neutrality of Money’, Journal of Economic Theory (1972a); ‘Some International Evidence on Output–Inflation Tradeoffs’, American Economic Review (1973); ‘Econometric Policy Evaluation: A Critique’ in The Phillips Curve and Labor Markets (North-Holland, 1976); ‘On the Mechanics of Economic Development’, Journal of Monetary Economics (1988); ‘Nobel Lecture: Monetary Neutrality’, Journal of Political Economy (1996); and ‘Macroeconomic Priorities’, American Economic Review (2003).

We interviewed Professor Lucas in New Orleans, in his hotel room, on 3 January 1997 while attending the annual conference of the American Economic Association.

Background Information

As an undergraduate you studied history at the University of Chicago and you also started graduate school as a student of history at Berkeley. Why did you decide to switch to study economics as a postgraduate student back at Chicago?

I was getting more interested in economics and economic history as a history student. The work of Henri Pirenne, the Belgian historian, who stressed economic forces influenced me. When I was at Berkeley I started taking some economic history classes and even attended an economics course. That is when I first learned what a technical field economics is and how impossible it would be to pick it up as an amateur. I decided then that I wanted to switch to economics. I didn’t have any hope of financial support at Berkeley to study economics so that was what led me back to Chicago.

Did you find the techniques and tools used by economists difficult to master when you did make the switch?

Sure, but it was exciting for me. I had no idea that people were using mathematics for social science questions before I got into economics. Once I became aware of that I enjoyed it enormously.

Was mathematics a strong subject for you when you were in high school?

In high school it was and in college I took a little bit, but dropped out. I was not interested in hard science. I wasn’t really motivated to keep going in

maths, but when I learned how maths was being used in economics it rekindled my interest in the field.

Which economists have had the most influence on your own work?

Dozens and dozens of people. Samuelson’s Foundations was a big influence when I started graduate school. His book was just a bible for my generation of economists. Friedman was a great teacher, really an unusual teacher. Anyone from Chicago will tell you that.

In what respect? Was it his ability to communicate complex ideas?

That’s a hard question to answer. I think it was the breadth of problems he showed that you could address with economic reasoning. That’s what Friedman emphasized. No single problem was analysed all that deeply but the range of problems included everything. So we got the impression, and rightly so, that we were getting a powerful piece of equipment for dealing with any problem that came up in human affairs.

To what extent did the work of the Austrians (Hayek and so on) influence your ideas?

I once thought of myself as a kind of Austrian, but Kevin Hoover’s book persuaded me that this was just a result of my misreading of Hayek and others.

David Laidler [1992b] has drawn attention to what he described as ‘the appalling low standards of historical scholarship amongst economists’. Is it important for an economist to be a competent historian?

No. It is important that some economists be competent historians, just as it is important that some economists be competent mathematicians, competent sociologists, and so on. But there is neither a need nor a possibility for everyone to be good at everything. Like Stephen Dedalus, none of us will ever be more than a shy guest at the feast of the world’s culture.

Keynes’s General Theory and Keynesian Economics

You were born in 1937. The Great Depression was a huge influence on economists such as Friedman, Samuelson and Tobin in stimulating their interest in economics in the first place. Do you regard the Great Depression as the premier macroeconomic event of the twentieth century?

I think that economic growth, and particularly the diffusion of economic growth to what we used to call the Third World, is the major macroeconomic event of the twentieth century. But the Great Depression is a good second. I was too young to know what was going on at the time, but the Depression

was the main influence on my parents. They became politically aware during the 1930s. Politics and economics were issues that were always talked about in my house when I was growing up.

How important do you think historical events are for theoretical developments? For example it is generally recognized that the Great Depression led to the General Theory.

Absolutely.

Do you think they are crucial?

Yes, I like that example.

What about the influence of increasing inflation in the 1970s? Do you think that event played the same kind of role in the move away from Keynesian economics, just as the Great Depression led to the development of Keynesian economics?

The main ideas that are associated with rational expectations were developed by the early 1970s, so the importance of the inflation that occurred was that it confirmed some of these theoretical ideas. In a way the timing couldn’t have been better. We were arguing that there was no stable Phillips curve relating unemployment and inflation. You could go either way on that question given the available post-war data up to the early 1970s, but by the end of the 1970s it was all over.

How do you view Keynes as a macroeconomist?

I suppose Keynes, via Hicks, Modigliani and Samuelson, was the founder of macroeconomics, so one has to view him as a leading figure in the field!

Robert Solow [1986] has described the General Theory as ‘the most influential work of economics of the twentieth century, and Keynes as the most important economist’. Yet the impression one gets from your various comments on Keynes is that you find the General Theory almost incomprehensible. You certainly don’t seem to regard it in the same light as Solow.

If you look through Solow’s collected writings for evidence of intellectual indebtedness, evidence that scholars look for – citations and transfer of ideas – you would find almost no influence of Keynes. So I think such comments are somewhat disingenuous, unless he is thinking simply of ideology. Of course Keynes is an extremely important figure in twentiethcentury history, but I think his major influence was ideological. The Depression followed soon after the Russian revolution, and there was a lot of idealism about socialism as a way of resolving economic problems, especially as the Soviet Union had no depression. Keynes went to great

lengths to disassociate himself from the rest of the economics profession in the General Theory, making almost no references to mainstream economists in the entire book, compared to the Treatise on Money which is full of references to mainstream economists. The message of the General Theory, in which he emphasized the seriousness of depressions, is that they can be solved within the context of a liberal democracy without having to resort to centralized planning. That was a highly important message which certainly sustained defenders of democracy in countries like yours and mine that maintained it. It helped to organize the entire world after the war and was the flag around which liberal democracies rallied. The General Theory was an unusually important book in that sense. Maybe more important than economic theory. But that seems to be a different question from that of the influence of Keynes’s theoretical ideas on the way we practise economics, which I think is now very slight.

Should students of macroeconomics still read the General Theory?

No.

Had Keynes still been living in 1969, do you think he would have been awarded the first Nobel Prize in Economics? Would he have received your vote?

I thought Joan Robinson would get the first one, so my credentials as a Nobel forecaster have been dubious from the start. But certainly Keynes would have got one early on. Since I am not a member of the Swedish Academy, I do not have a vote to cast.

Do you find it puzzling that both Keynes and Marshall started off as mathematicians and yet both of them in terms of their methodology seemed to downplay the use of mathematics in economics, not regarding it as an important way of setting down economic ideas? Why do you think they turned away from what was becoming a major trend in economic science?

When Marshall was educated, and even when Keynes was educated, England was a mathematical backwater. If they had been educated in France, Germany or Russia, working with people like Kolmogorov, Borel or Cantor, they would have thought differently. Walras, Pareto and Slutzky thought differently. The people who were giving birth to mathematical economics were mainly on the continent at that time.

Is it your view that the traditional approach of distinguishing between short-run and long-run forces in macroeconomics has been misconceived and counterproductive? Did Keynes send everyone off down the wrong track?

The short-run–long-run distinction is Marshall’s, not Keynes’s. Indeed, Keynes is quite explicit in the General Theory that he thinks that permanent stagnation can result from demand deficiencies. Samuelson’s neoclassical synthesis reclaimed the long run for neoclassical analysis, at least here in the USA. Now Samuelson’s students – my whole generation – are trying to get the short run back, too! It’s hard going, I know, but Samuelson already did the easy part, and we have to make a living somehow.

The 1930s sent all of us off on the wrong track, starting with Keynes. Even today, 50 years after the Depression ended, public figures talk about every little wiggle in the GNP figures as though it were the end of capitalism. If Keynes were alive today, he would take pride in his role in setting up the system that permitted the recovery of Europe and the Japanese miracle, and he would be excited about the prospects for integrating the second and third worlds into the world economy. I think he would be as impatient with the overemphasis on short-term fine-tuning as I am.

Monetarism

What were the major factors which contributed to the rise of monetarism both in academia and policy circles during the 1970s?

It is hard for me to say because I was raised as a monetarist in the 1960s [laughter].

Well, in the UK circumstances were very different, monetarist ideas came as much more of a shock to many British economists who were steeped in what Coddington [1976] has labelled ‘hydraulic Keynesianism’ and Samuelson [1983] has referred to as the ‘Model T’ version of Keynes’s system.

Our leading Keynesian theorists, people like Tobin and Modigliani, always had a role for money in their models and the models that I learnt as a graduate student. Isn’t it true that in England monetarism is used as a much broader label for the whole Thatcher programme?

The UK media has certainly tended to think of supply-side economics and monetarism as being the same. Sometimes any belief in the market mechanism and laissez-faire philosophy is also classified as being a part of monetarism.

You can take the various elements separately and mix them any way you like.

Do you see Friedman as almost single-handedly having engineering a monetarist counter-revolution?

Friedman has been an enormous influence. It is hard to say what would have happened without him.

We know from our own experience as undergraduate students of economics in the late 1960s in Britain that Friedman was often portrayed as some sort of strange crank in Chicago.

Well, that was the way people tried to deal with him here too in a way, but not successfully.

Moving on to Friedman’s 1968a AER article. In 1981 Robert Gordon described it as probably the most influential article written in macroeconomics in the previous 20 years, while more recently James Tobin [1995] has gone much further when he described it as ‘very likely the most influential article ever published in an economics journal’. What importance do you attach to that particular article?

It had a huge influence on me. Leonard Rapping and I were doing econometric work on Phillips curves in those days and that paper hit us right when we were trying to formulate our ideas. Our models were inconsistent with Friedman’s reasoning and yet we couldn’t see anything wrong with his reasoning. It was a real scientific tension of trying to take two incompatible points of view and see what adjustments you can make to end up in a coherent position. Edmund Phelps was pursuing similar ideas. Phelps spelled out the theory a little more clearly than Friedman did and he had an enormous influence on me as well.

Was this with respect to the need for microfoundations?

Yes. I always think of the proposition that there is no long-run Phillips tradeoff as the Friedman–Phelps proposition.

What do you feel remains of the monetarist counter-revolution today?

It has gone in so many different directions. Rational expectations macroeconomics has gone in many different directions. There is real business cycle theory which assigns no importance to monetary forces. This work has been hugely influential, on me as well as on others, although I still think of myself as a monetarist. Then there are those whom Sargent calls fiscalists, people who think that government deficits are crucial events for the determination of inflation and whether they are financed by bond issues or money issues is secondary, or maybe not relevant at all. Then there are old-fashioned monetarists, which is where I would class myself, with people like Friedman and Allan Meltzer. One of the things that people are coming to agree on, although not too many come right out and say it, is that econometrically it seems to be hard to account for more than a quarter to a third of US real variability in the post-war period to monetary forces, no matter how you look at the data. People from very different points of view have come up with that as a kind of upper bound. I used to think that monetary shocks were 90 per cent of the

story in real variability and I still think they are the central story in the 1930s. But there is no way to get monetary shocks to account for more than about a quarter of real variability in the post-war era. At least, no one has found a way of doing it.

One of the consensus propositions now is that monetary forces cause inflation, certainly in the long term. That still leaves open the question, if we know what causes inflation, why do governments insist on increasing the money supply too rapidly? What are the forces which lie behind monetary expansions?

Well, to be fair, since the 1970s the advanced capitalist countries have what I would regard as a fantastic record on inflation. Every central bank has shifted its focus exclusively, or almost exclusively, on price stability. They have done a great job. I like the idea of going from 3 per cent to 0, but the big thing is going from 13 per cent to 3. Everyone would agree with that. So the record in the advanced countries has just been tremendous, although there are a few outliers in some Latin America countries where inflation is still a persistent problem. Chile, though, has dealt with inflation forcefully and they have had a solid record for ten years. Country after country is coming around to deal with inflation by restricting money growth. But there is still ignorance and there is always going to be a temptation to generate surprise inflation in order to default on obligations.

Do you think that Democratic governments will tend to generate in the long term more inflation than Republican governments because of their greater announced commitment to employment targets?

Easy money and tight money have been an issue in the USA since the nineteenth century. I guess it is a pretty good generalization that the Republicans on the whole have been a tight money party.

According to Alberto Alesina’s [1989] rational partisan model it should generally be better.

I think of Nixon and Ford as having been fairly inept at monetary policy (laughter).

Alan Blinder [1986, 1988b, 1992b] has argued that during the 1970s American Keynesianism absorbed the Friedman–Phelps proposition and that after allowing for the effects of the OPEC supply shock, a modified Keynesian model was quite capable of explaining the 1970s macroeconomic phenomena. Do you think he is wrong?

The direct effect of the OPEC shock was minor in my opinion. I like to be more explicit about which models are being discussed and what properties