Testing the lucas critique: A review

Abstract

Claims that the parameters of an econometric model are invariant under changes in either policy rules or expectations processes entail super exogeneity and encompassing implications. Super exogeneity is always potentially refutable, and when both implications are involved, the Lucas critique is also refutable. We review the methodological background; the applicability of the Lucas critique; super exogeneity tests; the encompassing implications of feedback and feedforward models; and the role of incomplete information. The approach is applied to money demand in the u.S.A. to examine constancy, exogeneity, and encompassing, and reveals the Lucas critique to be inapplicable to the model under analysis.

Keywords:

• Constancy
• Encompassing
• Exogeneity
• Expectations
• Invariance
• Lucas Critique
• Money Demand