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Discussion Paper Details

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Title: Labor-Market Heterogeneity, Aggregation, and the Lucas Critique

Author(s): Yongsung Chang and Frank Schorfheide

Publication Date: October 2010

Keyword(s): Aggregation, Fiscal Policy, Heterogeneous Agents Economy, Lucas Critique and Representative Agent Model

Programme Area(s): International Macroeconomics

Abstract: This paper assesses biases in policy predictions due to the lack of invariance of ``structural'' parameters in representative-agent models. We simulate data under various fiscal policy regimes from a heterogeneous-agents economy with incomplete asset markets and indivisible labor supply. Imperfect aggregation manifests itself through preference shocks in the estimated representative-agent model. Preference and technology parameter estimates are not invariant with respect to policy changes. As a result, the bias in the representative-agent model's policy predictions is large compared to the length of predictive intervals that reflect parameter uncertainty.

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Bibliographic Reference

Chang, Y and Schorfheide, F. 2010. 'Labor-Market Heterogeneity, Aggregation, and the Lucas Critique'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=8039