MainstreamFrom 1972
New classical and real business cycles
Can we build macroeconomics from individuals who optimise and form rational expectations?
The 30-second version
What if people are smart and look ahead? Then predictable policy may achieve little, because people see it coming. This 1970s revolution changed how all macro models are built, even though most economists rejected its conclusion that recessions are efficient.
Big questions it works on
Go deeperKey ideas, thinkers, evidence and where it stands today
Key ideas
- Rational expectations: people use all available information and are not systematically fooled (Muth, 1961; Lucas).
- The Lucas critique: policy must be analysed with models whose parameters do not shift when policy shifts.
- Anticipated policy may have little real effect.
- Real business cycles: booms and busts are efficient responses to productivity shocks (Kydland and Prescott, 1982).
Key thinkers
Robert Lucas (Nobel 1995), Thomas Sargent, Finn Kydland and Edward Prescott (Nobel 2004), Robert Barro
What it got right
Its methods won. Expectations and microfoundations are standard in every modern macro model. Its work on time inconsistency strengthened the case for independent central banks.
Main criticisms
It struggles to explain involuntary unemployment. Treating recessions as “technology regress” is hard to believe. In 2003 Lucas said the central problem of depression prevention had been solved; 2008 followed.
Evidence worth knowing
Most of its policy conclusions were not adopted, even though its modelling style was.
Where it stands today
Its tools are the scaffolding of mainstream macro; its strongest conclusions are a minority view.
Family line
Reacting against Keynesian models after the 1970s stagflation.