Bob Lucas, the Most Influential Macroeconomist of the Last Quarter of the 20th Century

T his week, Robert E. Lucas Jr. or “Bob Lucas,” a University of Chicago macroeconomist who won the Nobel Prize in Economics in 1995, passed away. In many respects, Lucas transformed how macroeconomics was done in the last quarter of the 20th century. He, and other Nobel Prize-winning economists Thomas Sargent and Ed Prescott, ushered in the “rational expectations revolution” in the 1970s, which ousted the then-dominant Old Keynesian paradigm.

Though John Maynard Keynes and Milton Friedman are often considered the greatest macroeconomists of the early and mid 20th century, Harvard economist Greg Mankiw once called Lucas “the most influential macroeconomist of the last quarter of the 20th century.” This would be a well-deserved title thanks to the many ideas Lucas produced over his career.

One of Lucas’s key contributions was stressing the addition of rational expectations into macroeconomic models. While agents may not be all that rational in reality, the idea that agents are forward-looking was a huge advance at the time. At the time, the U.S. economy was being ravaged by stagflation, fighting both high unemployment and high inflation at the same time. Old Keynesian models had a tough time explaining this phenomenon, as Lucas and Thomas Sargent explained in their famous 1979 essay “After Keynesian Macroeconomics”:

In the present decade, the U.S. economy has undergone its first major depression since the 1930s, to the accompaniment of inflation rates in excess of 10 percent per annum. These events have been transmitted . . . to other advanced countries and in many cases have been amplified. These events did not arise from a reactionary reversion to outmoded, ‘classical’ principles of tight money and balanced budgets. On the contrary, they were accompanied by massive government budget deficits and high rates of monetary expansion, policies which, although bearing an admitted risk of inflation, promised according to modern Keynesian doctrine rapid real growth and low rates of unemployment.

They further added:

That these [Keynesian] predictions were wildly incorrect and that the doctrine on which they were based is fundamentally flawed are now simple matters of fact, involving no novelties of economic theory. The task now . . . is to sort through the wreckage, determining which features of that remarkable intellectual event called the Keynesian Revolution can be salvaged and put to use and which others must be discarded.

This effectively amounted to a critique of old Keynesian models for failing to include rational, forward-looking agents that could potentially render some form of government policy as less effective, a critique that became known as the Lucas Critique. Going forward, all macroeconomic models since have included microfoundations and some sorts of agents which are then to be aggregated.

Their work also suggested that the economy could have central-bank-led disinflations without a large unemployment spell and recession. This might be what the U.S. economy is experiencing now in 2023 as inflation continues to fall while unemployment remains near all-time lows.

The Lucas Islands model, developed in a series of papers by Lucas in the early 1970s, was another essential model developed by Lucas. It suggested that monetary policy could only influence unemployment through unexpected changes in inflation. This idea was encapsulated in the idea of the expectations-adjusted New Classical Phillips Curve. Additionally, in 1978, Lucas published “Asset Prices In An Exchange Economy,” which developed his “Lucas tree” model of asset prices and is still used to this day in academic finance.

In the 1980s, Lucas stopped doing work on business cycles (the subject that had originally made him famous in his work on rational expectations) once he realized that the concerns of broad-based economic growth and long-term economic trends far outweighed the importance of business-cycle fluctuations. In other words, a recession that may cause the U.S. — per capita — to lose 5 percent of GDP (like during the Great Recession) pales in comparison to the fact that U.S. GDP per capita has grown 300 percent in real terms from the end of World War II to 2023, or the fact that the GDP per capita of the U.S. remains 550 percent greater than the GDP per capita of China or 3,100 percent greater than the GDP per capita of India.

Lucas famously wrote, in what would become his most cited paper, “On The Mechanics of Economic Development,” that “the consequences for human welfare involved in questions like these are simply staggering: Once one starts to think about them, it is hard to think about anything else.”

In fact, it was in the context of thinking about why some countries such as South Korea, India, Taiwan, and Hong Kong experienced growth “miracles” while countries such as India remained poor. (That India remains comparatively poor is largely true even 35 years after the article was released.) He asked what the government of India could do from a policy perspective to make it even marginally more well off like countries such as Indonesia or Egypt:

Indeed, it is so true how vastly the average living standards differ across countries and across time. I recall that as an undergraduate at the University of Chicago during the Great Recession, my economics student group invited Lucas to speak to us. While most other economists at the time were focused on explaining the intricacies of the banking system or how monetary policy worked, Lucas gave us one chart, the simplicity of which came as a shock:

The point Lucas was trying to make was that long-run economic growth on GDP dwarfs the impact of business-cycle fluctuations (recessions), even deep ones such as the Great Depression and the Great Recession. While it may seem uncharacteristic of what gets highlighted in the financial media or mainstream news (which gets hung up on day-to-day asset-price fluctuations from the financial markets), long-term economic growth matters, whether it be in the U.S. or Africa.

Lucas had it right that the primary concern among economists should be how to help those who are least among us by improving their economic conditions. It’s a mission I, in my research position at the Foundation For Research on Equal Opportunity, and many other economists try to maintain in our work going forward.