TY  - JOUR
AU  - Caballero,Ricardo J.
AU  - Engel,Eduardo
TI  - Adjustment is Much Slower than You Think
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 9898
PY  - 2003
Y2  - August 2003
UR  - http://www.nber.org/papers/w9898
L1  - http://www.nber.org/papers/w9898.pdf
N1  - Author contact info:
Ricardo J. Caballero
MIT
Department of Economics
Room E52-373a
Cambridge, MA 02142-1347
Tel: 617/253-0489
Fax: 617/253-6915
E-Mail: caball@mit.edu

Eduardo Engel
Yale University
Department of Economics
P.O. Box 208268
New Haven, CT  06520-8268
Tel: 203/432-5595
Fax: 203/432-5779
E-Mail: eduardo.engel@yale.edu
AB  - In most instances, the dynamic response of monetary and other policies to shocks is infrequent and lumpy. The same holds for the microeconomic response of some of the most important economic variables, such as investment, labor demand, and prices. We show that the standard practice of estimating the speed of adjustment of such variables with partial-adjustment ARMA procedures substantially overestimates this speed. For example, for the target federal funds rate, we find that the actual response to shocks is less than half as fast as the estimated response. For investment, labor demand and prices, the speed of adjustment inferred from aggregates of a small number of agents is likely to be close to instantaneous. While aggregating across microeconomic units reduces the bias (the limit of which is illustrated by Rotemberg's widely used linear aggregate characterization of Calvo's model of sticky prices), in some instances convergence is extremely slow. For example, even after aggregating investment across all establishments in U.S. manufacturing, the estimate of its speed of adjustment to shocks is biased upward by more than 80 percent. While the bias is not as extreme for labor demand and prices, it still remains significant at high levels of aggregation. Because the bias rises with disaggregation, findings of microeconomic adjustment that is substantially faster than aggregate adjustment are generally suspect.
ER  -