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.
We thank participants at various seminars for helpful comments. Schorfheide gratefully acknowledges financial support from the National Science Foundation under Grant SES 0617803. Chang acknowledges the support from WCU (WCU-R33-10005) Program through the Korean National Research Foundation. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
“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.