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Partial Adjustment without Apology

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  • Robert G. King
  • Julia K. Thomas

Abstract

Many kinds of economic behavior appear to be governed by discrete and occasional individual choices. Despite this, econometric partial adjustment models perform relatively well at the aggregate level. Analyzing the classic employment adjustment problem, we show how discrete and occasional microeconomic adjustment is well described by a new form of partial adjustment model that aggregates the actions of a large number of heterogeneous producers. We begin by describing a basic model of discrete and occasional adjustment at the micro level, where production units are essentially restricted to either operate with a fixed number of workers or shut down. We show that this simple model is observationally equivalent at the market level to the standard rational expectations partial adjustment model. We then construct a related, but more realistic, model that incorporates the idea that increases or decreases in the size of an establishment's workforce are subject to fixed adjustment costs. In the market equilibrium of this model, employment responses to aggregate disturbances include changes both in employment selected by individual establishments and in the measure of establishments actively undertaking adjustment. Yet the model retains a partial adjustment flavor in its aggregate responses. Moreover, in contrast to existing models of discrete adjustment, our generalized partial adjustment model is sufficiently tractable to allow extension to general equilibrium.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9946.

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Date of creation: Sep 2003
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Publication status: published as Robert G. King & Julia K. Thomas, 2006. "Partial Adjustment Without Apology," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 47(3), pages 779-809, 08.
Handle: RePEc:nbr:nberwo:9946

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  1. Aubhik Khan & Julia K. Thomas, 2000. "Nonconvex factor adjustments in equilibrium business cycle models: do nonlinearities matter?," Working Papers 00-10, Federal Reserve Bank of Philadelphia.
  2. Mortensen, Dale T, 1973. "Generalized Costs of Adjustment and Dynamic Factor Demand Theory," Econometrica, Econometric Society, vol. 41(4), pages 657-65, July.
  3. Ricardo J. Caballero & Eduardo M. R. A. Engel, 1999. "Explaining Investment Dynamics in U.S. Manufacturing: A Generalized (S,s) Approach," Econometrica, Econometric Society, vol. 67(4), pages 783-826, July.
  4. Ricardo J. Caballero & Eduardo Engel & John Haltiwanger, 1996. "Aggregate Employment Dynamics: Building from Microeconomic Evidence," Documentos de Trabajo 6, Centro de Economía Aplicada, Universidad de Chile.
  5. Daniel S. Hamermesh & Gerard A. Pfann, 1996. "Adjustment Costs in Factor Demand," Journal of Economic Literature, American Economic Association, vol. 34(3), pages 1264-1292, September.
  6. Hamermesh, Daniel S., 1990. "Aggregate employment dynamics and lumpy adjustment costs," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 33(1), pages 93-129, January.
  7. Julia K. Thomas, 2002. "Is lumpy investment relevant for the business cycle?," Staff Report 302, Federal Reserve Bank of Minneapolis.
  8. Hamermesh, Daniel S, 1989. "Labor Demand and the Structure of Adjustment Costs," American Economic Review, American Economic Association, vol. 79(4), pages 674-89, September.
  9. Caballero, Ricardo J & Engel, Eduardo M R A, 1992. "Beyond the Partial-Adjustment Model," American Economic Review, American Economic Association, vol. 82(2), pages 360-64, May.
  10. Caballero, Ricardo J & Engel, Eduardo M R A, 1993. "Microeconomic Adjustment Hazards and Aggregate Dynamics," The Quarterly Journal of Economics, MIT Press, vol. 108(2), pages 359-83, May.
  11. Thomas J. Sargent, 1978. "Estimation of dynamic labor demand schedules under rational expectations," Staff Report 27, Federal Reserve Bank of Minneapolis.
  12. Michael Dotsey & Robert G. King & Alexander L. Wolman, 1999. "State-Dependent Pricing And The General Equilibrium Dynamics Of Money And Output," The Quarterly Journal of Economics, MIT Press, vol. 114(2), pages 655-690, May.
  13. Parente, Stephen L & Prescott, Edward C, 1994. "Barriers to Technology Adoption and Development," Journal of Political Economy, University of Chicago Press, vol. 102(2), pages 298-321, April.
  14. Robert G. King & Sergio T. Rebelo, 2000. "Resuscitating Real Business Cycles," RCER Working Papers 467, University of Rochester - Center for Economic Research (RCER).
  15. Kennan, John, 1979. "The Estimation of Partial Adjustment Models with Rational Expectations," Econometrica, Econometric Society, vol. 47(6), pages 1441-55, November.
  16. Kollintzas, Tryphon, 1985. "The Symmetric Linear Rational Expectations Model," Econometrica, Econometric Society, vol. 53(4), pages 963-76, July.
  17. Lucas, Robert E, Jr & Prescott, Edward C, 1971. "Investment Under Uncertainty," Econometrica, Econometric Society, vol. 39(5), pages 659-81, September.
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