Sargent: Little or nothing. Lucas used evidence of coefficient drift and
add factors to bash the Keynesians, but as I read his paper, at least, he didn’t
claim to offer an explanation for the observed drift. His three examples are each
time-invariant structures. Data from them would not have coefficient drift even
if you fit one of those misspecified Keynesian models. So the connection of the
first part of his paper to the second was weak.
Evans and Honkapohja: Do you feel that your work contributed to the
Lucas critique?
Sargent: It depends what you mean by ‘contribute’. Lucas attended a
conference on rational expectations at the University of Minnesota in the spring
of 1973. The day after the conference, I received a call from Pittsburgh. Bob
had lost a manuscript and thought he might have left it at the conference. I
went to the room in Ford Hall at which we had held the conference and found
a folder with yellow sheets in it. I looked at the first few pages. It was Bob’s
Critique. I mailed the manuscript back to Bob. So, yes, I contributed to the
Critique.
Evans and Honkapohja: What were the profession’s most important
responses to the Lucas Critique?
Sargent: There were two. The first and most optimistic response was
complete rational expectations econometrics. A rational expectations equilib-
rium is a likelihood function. Maximize it.
Evans and Honkapohja: Why optimistic?
Sargent: You have to believe in your model to use the likelihood func-
tion. It provides a coherent way to estimate objects of interest (preferences,
technologies, information sets, measurement processes) within the context of a
trusted model.
Evans and Honkapohja: What was the second response?
Sargent: Various types of calibration. Calibration is less optimistic
about what your theory can accomplish because you’d only use it if you didn’t
fully trust your entire model, meaning that you think your model is partly
misspecified or incompletely specified, or if you trusted someone else’s model and
data set more than your own. My recollection is that Bob Lucas and Ed Prescott
were initially very enthusiastic about rational exp ectations econometrics. After
all, it simply involved imposing on ourselves the same high standards we had
criticized the Keynesians for failing to live up to. But after about five years of
doing likelihood ratio tests on rational expectations models, I recall Bob Lucas
and Ed Prescott both telling me that those tests were rejecting too many good
models. The idea of calibration is to ignore some of the probabilistic implications
of your model, but to retain others. Somehow, calibration was intended as a
balanced response to professing that your model, though not correct, is still
worthy as a vehicle for quantitative policy analysis.
Evans and Honkapohja: Why do you say ‘various types of calibration’ ?