ECONOMIC-EXPECTATIONS PIONEER EARNS NOBEL PRIZE

Author: By David Warsh, Globe Staff

Date: Wednesday, October 11, 1995
Page: 39
Section: BUSINESS

In making the award, the committee of the Swedish Academy of Sciences leapfrogged over some serious work of the 1950s and 1960s and pinned the medal to the leading figure of the 1970s -- thereby signaling their view of a discontinuity between the older generation of economists and the new.

"Robert Lucas is the economist who has had the greatest influence on macroeconomic research since 1970," the citation said.

Lucas is the principle formulator of the rational expectations hypothesis, the assumption that people make use of the best available information about government policy when making their decisions rather than committing the systematic errors assumed by earlier theory.

As a result, activist government policy to stabilize the economy would either have no effect -- or, more likely, would make matters worse, Lucas argued in a series of papers beginning in 1972.

He thereby "transformed macroeconomic analysis and deepened our understanding of economic policy," the citation said.

Noting the custom among waggish economists to reduce the intricate reasoning behind each award to a pithy phrase -- don't put all your eggs in one basket, most people save for a rainy day -- one wag suggested that Lucas' motto could be, "Fool me once, shame on you; fool me twice, shame on me."

A simple example of rational expectations behavior might involve the introduction of sharp discounts to stimulate the sale of automobiles. Consumers might buy a few more cars at cut-rate prices than they might have otherwise the first time such incentives were introduced -- but the auto- buying public would quickly learn to time purchases to coincide with such sales in the future.

When applied to the economy as a whole, such chains of reasoning undermine most of the Keynesian economic theory that was published before the 1970s. Work on such "microfoundations" of theory applied to the economy as a whole had begun a few years earlier independently by Edmund Phelps of Columbia University and Milton Friedman of the University of Chicago. But Lucas achieved far greater generality through the use of sophisticated mathematical reasoning.

His formal models seemed to entail surprising policy conclusions as well: the conviction that the economy was essentially self-correcting, regardless of how policy was pursued. Such "new classical" thinking vied for loyalty among a younger generation of economists who had earlier been taught that only aggressive government management could forestall periodic depressions.

In this, as well as its refinements in technique, Lucas' work was highly controversial. The leading journals refused to publish his initial paper, which was subsequently accepted by a feisty start-up, the Journal of Economic Theory. Karl Shell, its editor, said yesterday that Lucas' contribution was built on "three giant predecessors: the notion of rational expectations itself, which had been introduced by John Muth; the overlapping generations model of Paul Samuelson; and an early use of the idea of asymetric information
from the island model of Edmund Phelps."

Because it was aimed squarely at the Keynesian tradition of economic engineering that had flourished during the 1950s and 1960s at the Massachusetts Institute of Technology, the rational expectations model touched off an intense battle between MIT and the University of Chicago. It was a battle that Chicago subsequently won. Five of the last six Nobel Prizes in economics, including Lucas, have gone, at least in part, to Chicago professors.

But in the end, Chicago changed as well. Lucas' devotion to high "general equilibrium" formalism -- in which an attempt is made to reckon all the consequences emanating from a particular action -- displaced over the course of the 1970s the one-thing-at-a-time methods favored by Chicago's Milton Friedman. In the end, Friedman moved to California and Lucas' high-tech style became that of the department.

Bennett McCallum of Carnegie Mellon University, who has chronicled the triumph of rational expectations methodology, said yesterday, "Lucas is utterly serious about substantive economics. He never uses three words if one will do. That sometimes makes conversation difficult. You have to work at it. But the elegance of his prose is striking."

Lucas is perhaps the last of the all-but-certain Chicago Nobel Prizes, though other scholars there stand a pretty good chance as the years roll on -- Eugene Fama for empirical finance, Thomas Sargent for his work on learning and monetary policy.

That didn't bother them in Hyde Park yesterday. The gothic campus on the Chicago's crumbling South Side has a reputation as a somewhat dreary place to be, having placed last among 300 colleges in a recent survey of fun schools.

It recently has been bragging about not only having established a student union, but having attracted a Starbuck's Coffee Cafe as well. But at a press conference yesterday, University of Chicago president Hugo Sonneshein, himself an economist of considerable distinction, crowed, "In Chicago, this is how we have fun!"

WARSH ;10/10 NKELLY;10/12,14:37 NOBEL11