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.
Document Object Identifier (DOI): 10.3386/w16401
Published: “Labor Market Heterogeneity and the Lucas Critique,” joint with Yongsung Chang (Rochester), and Sun - Bin Kim (Yonsei University), Journal of the European Economic Association , 11(S1), 2013, 193 - 220.
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