Robust Decision Theory and the Lucas Critique¤

In this paper we re-consider the theoretical basis for the Lucas Critique from the point of view of Robust Decision Theory. We ...rst emphasise that the Lucas Critique rests on a weak theoretical paradigm in that it fails to consider the motivation for the policy change by the government and hence inconsistently assumes limited rationality by the government. When placed in a proper dynamic general equilibrium framework of a dynamic game between the government and the private sector much of the force of the critique simply vanishes. We also re-consider the Critique by adopting an alternative theoretical paradigm and notion of rationality based on robust decision theory. This view of rationality might be regarded as more relevant than the non-robust rationality employed by Lucas and critically it is one in which the Lucas Critique can be shown to simply not apply provided the private sector has adopted suitably robust decision rules. ¤First Version 1996. This paper incorporates arguments made originally in previously unpublished papers by the two authors; Salmon (1981),(1984) and Marcellino (1995) and represents an abridged version of Marcellino and Salmon (2002). We would like to thank Tom Sargent, Ken Kasa and Ian Petersen for comments on earlier versions and helpful discussions.