Robert Lucas, the Nobel laureate who revolutionised macroeconomics

His work forms the basis of modern macroeconomic theory. How policy, particularly monetary policy, should be formulated stems squarely from his research and writings. But his influence goes beyond this. His work played a significant role in reconciling the previously divergent paths of microeconomics and macroeconomics. It helped develop the discipline of economics into a cohesive and logical framework of inquiry.

Lucas is best known for, as the Nobel Prize announcement in 1995 states, “having developed and applied the hypothesis of rational expectations, and thereby having transformed macroeconomic analysis and deepened our understanding of economic policy".

This idea, that people change their expectations based on the policy in place and hence cannot be fooled by policy surprises, is so well understood today that it needs no further explanation. An important outcome of his work is that it has reduced policy ad hocism. Notably, monetary policymaking has largely become rule-based across the globe. He embedded this idea of rational expectations in an equilibrium framework in a paper, ‘Investment under Uncertainty’, in 1971 with his long-time collaborator Edward Prescott, another stalwart macroeconomist and Nobel Laureate who passed away recently. However, the most influential paper in this regard, as also acknowledged by Lucas himself, is the 1972 paper ‘Expectations and Neutrality of Money’.

During this period of the 1970s, Lucas not only revolutionised the way we think about macro questions like recessions and policymaking but also developed a framework to analyse macro issues. He and his collaborators worked in two dimensions – embedding macro problems within the general equilibrium framework and studying dynamics. There were two versions of the general equilibrium model, one developed by the likes of Arrow, Debreu and McKenzie with infinitely lived agents, and one developed by Samuelson, with overlapping generations. He used both. This framework, further developed by others (especially Brock and Mirman (1972) and Kydland and Prescott (1982)), remains the mainstay of macroeconomic models, including the now ubiquitous and computable Dynamic Stochastic General Equilibrium (DSGE) models.

The great mind that he was, he did not limit his inquisition to short-term fluctuations of the economy, but asked extremely important questions about the long-run growth process. In his influential paper, “On the Mechanics of Economic Development," published in 1988, he asked why some countries are rich and others poor – a question he deemed so important that “once one starts to think about them, it is hard to think about anything else". Even today, I often ask my students, “Why doesn't capital flow from rich to poor countries?" to motivate them to think about cross-country variations when teaching them about growth.

These questions gave rise to a large set of papers that greatly improved our understanding of the growth process even though his own model, with human capital, was not the most widely accepted one within the profession. An important outcome of his work on growth was that it created unified models for developed and developing countries alike, just like it brought together micro assumptions and macro questions when he formulated models with rational expectations.

Lucas worked on and influenced a variety of other topics. Though some of these may not be discussed in popular articles, they have influenced researchers profoundly. My personal favourite is his 1978 paper ‘Asset Prices in an Exchange Economy’. He has also written about the size distribution of firms, search, unemployment, and incomplete information among other topics. One aspect of his papers is his lucid writing, which conveys an astounding clarity of thought.

It would be a travesty if I did not mention one of his books that I think has influenced the profession profoundly. ‘Recursive Methods in Economic Dynamics,’ co-written with his partner Nancy Stokey and in collaboration with Edward Prescott, provided the foundation for dynamic macroeconomics and was used to train generations of macroeconomists. Unlike most of his papers, which are quite accessible, even if mathematically sophisticated, this one requires a bit of investment from the reader but gives rich returns. I can vividly remember the frustration and joy of working through this book during my PhD program at the University of Minnesota.

It was there, in Minnesota, that I had the chance to meet and interact with him, though in a limited way. Even though he spent most of his career at the University of Chicago, his alma mater, he was associated with the Federal Reserve Bank of Minneapolis and, by virtue of that, with the Department of Economics at Minnesota.

He spent considerable time there in the late 1990s and early 2000s. I joined the PhD program at Minnesota during that period and first met him within the month or so. It was the start of the academic year and the faculty members and the graduate students gathered at the banks of Mississippi, which ran through the campus. By then, I knew most of the people in the department, but was still getting familiarised with everyone. There were one or two new faces. Someone introduced me to one of these – Bob Lucas! Like anyone who has studied even a bit of economics, I knew of Lucas through Rational Expectations and Lucas Critique and knew he was a Nobel Prize winner. And there I was, talking to him! He was welcoming and kind.

Subsequently, I would see him at seminars. He would ask questions, some critical of what was being presented, but always helpful. During that period, I also saw him present a paper – not on rational expectations, business cycles, long-term growth or any of the things we know him for. It was on the spatial structure of cities, which showed the range of his thinking.

The Nobel citation says, “Robert Lucas is the economist who has had the greatest influence on macroeconomic research since 1970." This is an understatement. His influence is far-reaching and I have no doubt he will continue to influence economics research even though he is no longer with us.

The author is a professor of economics at the Shiv Nadar Institution of Eminence.