Working Paper: NBER ID: w16401
Authors: Yongsung Chang; Sunbin Kim; Frank Schorfheide
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.
Keywords: Labor Market Heterogeneity; Aggregation; Lucas Critique; Fiscal Policy
JEL Codes: C11; C32; E32; E62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| fiscal policy changes (E62) | parameters of representative-agent models (E13) |
| lack of policy invariance (C54) | inaccurate predictions from representative-agent model (E17) |
| predicted effects of fiscal policy changes (H30) | actual outcomes in heterogeneous agents economy (D29) |
| preference shocks (D11) | hours worked (J22) |
| fiscal policy regime (E63) | aggregate labor supply elasticity (J20) |
| cross-sectional distribution of reservation wages (J31) | aggregate labor supply elasticity (J20) |