Discussion paper

DP8039 Labor-Market Heterogeneity, Aggregation, and the Lucas Critique

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.


Chang, Y and F Schorfheide (2010), ‘DP8039 Labor-Market Heterogeneity, Aggregation, and the Lucas Critique‘, CEPR Discussion Paper No. 8039. CEPR Press, Paris & London. https://cepr.org/publications/dp8039