Policy evaluations fail if they ignore expectation changes.
Lucas's 1976 critique: any relationship estimated under one policy regime may break when the regime changes, because people were optimising against the old rule. The breakdown of simple Phillips-curve relationships in the 1970s helped motivate the shift towards models in which expectations and policy rules affect behaviour.
In practice
- A model of consumer behaviour estimated before a tax change predicts badly after it, because consumers optimised against the old rule.
- A credit-scoring model that works well becomes public knowledge, applicants optimise against it, and it stops discriminating.
- Further reading
- Wikipedia
- Subject
- Economics & Incentives
- Essay
- The theories behind every argument about money