In their paper, " New Keynesian Models: Not Yet Useful for Policy Analysis"
V. V. Chari, Patrick J. Kehoe, and Ellen R. McGrattan
argue that one needs a structural model in order to analyse the effect of economic policy. More specifically, they argue that it needs enough microfoundations consistent with the data such that both the models's shocks and parameters are structural. But in my opinion, they don't really explain why that is the case.
I understand that IF it is the case, you can do policy analysis, and the results of this analysis will always apply, because the model is unchanged nevermind any policy. This was the Lucas critique, on models that used adaptive expectations.
Why is this the case? Isn't it reasonable to assume that, in addition to many economic variables, also many parameters that govern micro behaviour will be influenced by a policy shock? Which contradicts their claim? Or do they only say that those parameters related to the shock under consideration cannot change? Why not? Isn't it wishful thinking one can ever settle down on a structural, fixed, microfounded model, as too many parameters governing micro behaviour depend on too many things like institutions, policy, technology, ... ?
Additional question: expectation formation is a microfoundation I guess. So, if we use the adaptive/heterogeneous expectations approach instead of the rational expectation assumption: I guess if an agent switches from a fundamentalist rule to an trend following rule (see the book and papers by Cars Hommes and De Grauwe and Zi), this is a structural change to the model? Or is this not structural, because the switching is a structural part of the model? However, it is exactly this endogenous switching that happens in response to (policy) shocks. How does this switching relates to the condition that models should be structural in their shocks and parameters to be used for policy analysis?
Some more context below:
"We begin by clarifying the distinction between reduced form and structural shocks. This distinction is critical in policy analysis. The reason is that in order to do policy analysis, we need to predict the consequences of changes in policy both for outcomes of the standard economic variables and for welfare. Such a prediction is possible only with a structural model. Speci…cally, a structural model must have two ingredients. First, the relevant elements of the model— including the shocks— must be invariant with respect to the policy interventions considered. Second, the shocks must be interpretable, so that we know whether they are what could be thought of as “good shocks”that policy should accommodate or “bad shocks”that policy should o¤set. Shocks which have both of these properties are referred to as structural shocks and ones that do not are referred to as reduced-form shocks.
Proponents of the New Keynesian model argue that it is promising for two reasons. It represents a detailed economy that can generate the type of wedges we see in the data from interpretable primitive shocks; and second, it has enough microfoundations that both their shocks and parameters are structural, in that they can reasonably be argued to be invariant to monetary policy shocks. A model with both of these features would potentially be useful for monetary policy analysis."