Robert Lucas changes his mind on business cycles, again

Noah Smith discusses Bob Lucas on macro:

I find Bob Lucas more intriguing than any other economist of the last few decades. I'm always interested to read what he has to say, for example in this recent interview (hat tip to Steve Williamson).

Lucas is also near the top of my list and I should add that I generally enjoy reading whatever Noah has to say (although I don’t always agree). Here is the portion I found most intriguing:

Lucas on the causes of business cycles:

"I was [initially] convinced by Friedman and Schwartz that the 1929-33 down turn was induced by monetary factors...I concluded that a good starting point for theory would be the working hypothesis that all depressions are mainly monetary in origin. Ed Prescott was skeptical about this strategy from the beginning...

I now believe that the evidence on post-war recessions (up to but not including the one we are now in) overwhelmingly supports the dominant importance of real shocks. But I remain convinced of the importance of financial shocks in the 1930s and the years after 2008. Of course, this means I have to renounce the view that business cycles are all alike!"

In 1980, Lucas had written:

"If the Depression continues, in some respects, to defy explanation by existing economic analysis (as I believe it does), perhaps it is gradually succumbing under the Law of Large Numbers."

But with the post-2008 recession looking so similar to the Depression, it seems to have become clear to Lucas that the Law of Large Numbers will no longer do the trick. There must in fact be two types of recessions, with one (more frequent, less severe) type caused by "real shocks", and the other (rarer, more severe) type caused by "financial shocks".

That Lucas has now twice changed his ideas about the underlying causes of the business cycle - the most important question in all of business cycle theory - is in my opinion a reason to admire him. When the facts change, Lucas changes his mind, as any scientist should.

Lucas is clearly a brilliant thinker, yet despite his best efforts, he was unable to generate a theory of business cycles that could sustain experiences during his own lifetime. While his willingness to change his mind is commendable, the degree to which this trait garners admiration implies the sad truth that very few live up to this standard.

Moving beyond the sad state of science (economics), I find it partially validating that Lucas now admits to the possibility/reality of “financial shocks”. The most recent “financial shock” is a primary reason behind my decision to pursue a degree in economics and create this blog. My future research will most likely focus on the monetary origin of such shocks, although presumably in a different light than Lucas (and Noah) would envision.

As I endeavor to find a new theory that helps explain the underlying causes of business cycles, Lucas’ story offers a reminder not to adhere too strongly to any theory, model or research project and to let the facts speak for themselves.