Labor-Market Heterogeneity, Aggregation, and the Policy-(In)variance of DSGE Model Parameters

By Yongsung Chang, Sun-Bin Kim and Frank Schorfheide

http://d.repec.org/n?u=RePEc:roc:rocher:566&r=dge

Data from a heterogeneous-agents economy with incomplete asset markets and indivisible labor supply are simulated under various fiscal policy regimes and an approximating representative-agent model is estimated. Preference and technology parameter estimates of the representative-agent model are not invariant to policy changes and the bias in the representative-agent model’s policy predictions is large compared to predictive intervals that reflect parameter uncertainty. Since it is not always feasible to account for heterogeneity explicitly, it is important to recognize the possibility that the parameters of a highly aggregated model may not be invariant with respect to policy changes.

Interesting warning that a representative agent DSGE model may not be “deep” enough to take fully into account the Lucas Critique. Indeed, distribution matters sometimes and may bias our estimates of the deepest parameters.