Does the Lucas Critique Apply during Hyperinflation? Empirical Evidence from Four Hyperinflationary Episodes

Jesús Vázquez, Universidad del País Vasco

Abstract

Farmer (1991) suggests that in a model in which there are multiple rational expectations equilibria agents may find it useful to coordinate their expectations in a unique rational expectations equilibrium which is supported by a self-fulfilling forecast rule having the property of being immune to the Lucas Critique. In this paper, we test Farmer's hypothesis using data from hyperinflationary episodes. We believe that those episodes are suitable for testing this hypothesis because an agent who lives in a hyperinflationary environment usually faces frequent changes in policy regime. The agent may thus choose a self-fulfilling forecast rule which is immune to the Lucas Critique as a way of hedging against unanticipated policy regime switches. The empirical results show mixed evidence on Farmer's hypothesis during the hyperinflationary episodes studied.