Self-Confirming Equilibrium and the Lucas Critique

27 Pages Posted: 15 Nov 2007

See all articles by Drew Fudenberg

Drew Fudenberg

Massachusetts Institute of Technology (MIT)

David K. Levine

Washington University in St. Louis - Department of Economics; European University Institute - Robert Schuman Centre for Advanced Studies (RSCAS)

Date Written: November 2007

Abstract

We examine the role of off-path "superstitions" in macro-economics, and show how a false belief about off-path play is the key element underlying both the Lucas Critique and the game-theoretic concept of self-confirming equilibrium. However, the impact of false beliefs in these two cases is different: In the Lucas case, a policy maker's incorrect beliefs about off-path play can lead to the adoption of mistaken policy innovation. However, the consequences of such an innovation provide evidence that the belief that motivated them was wrong. In contrast, play may never escape an undesirable self-confirming equilibrium, as the action implied by the mistaken belief does not generate data that contradicts it; escape from the self-confirming equilibrium requires that players do a sufficient amount of experimentation with off-path actions.

Suggested Citation

Fudenberg, Drew and Levine, David K., Self-Confirming Equilibrium and the Lucas Critique (November 2007). Harvard Institute of Economic Research Discussion Paper No. 2142. Available at SSRN: https://ssrn.com/abstract=1030298 or http://dx.doi.org/10.2139/ssrn.1030298

Drew Fudenberg (Contact Author)

Massachusetts Institute of Technology (MIT) ( email )

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David K. Levine

Washington University in St. Louis - Department of Economics ( email )

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European University Institute - Robert Schuman Centre for Advanced Studies (RSCAS) ( email )

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