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Can a Representative-Agent Model Represent a Heterogeneous-Agent Economy?

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Abstract

Accounting for observed fluctuations in aggregate employment, consumption, and real wage using the optimality conditions of a representative household often requires preferences that are incompatible with economic priors (e.g., Mankiw, Rotemberg, and Summers 1985). This discrepancy between the equilibrium model and the aggregate data is often viewed as evidence of the failure of labor-market clearing. We argue that such a conclusion is premature. We construct a model economy where all prices are flexible and all markets clear at all times but household decisions are not readily aggregated because of incomplete capital markets and the indivisible nature of the labor supply. We demonstrate that if we were to explain the model-generated aggregate time series using decisions of a fictitious" stand-in household, such a household is likely to have a non-concave or unstable utility. Our analysis suggests that the representative-agent model often fails to represent an equilibrium outcome of a heterogeneous-agent economy.

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Bibliographic Info

Paper provided by University of Rochester - Center for Economic Research (RCER) in its series RCER Working Papers with number 542.

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Length: 39 pages
Date of creation: Sep 2008
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Handle: RePEc:roc:rocher:542

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Postal: University of Rochester, Center for Economic Research, Department of Economics, Harkness 231 Rochester, New York 14627 U.S.A.

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Keywords: Representative-agent model; Aggregation; Heterogeneity; Incomplete Markets; Indivisible Labor; GMM Estimation;

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  12. Gary Solon & Robert Barsky & Jonathan A. Parker, 1992. "Measuring the Cyclicality of Real Wages: How Important is Composition Bias," NBER Working Papers 4202, National Bureau of Economic Research, Inc.
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  14. Yongsung Chang & Sun-Bin Kim, 2003. "From Individual to Aggregate Labor Supply: A Quantitative Analysis Based on a Heterogeneous Agent Macroeconomy," Macroeconomics, EconWPA 0307003, EconWPA.
  15. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, Econometric Society, vol. 50(6), pages 1345-70, November.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Heterogeneity is crucial for business cycle models
    by Economic Logician in Economic Logic on 2009-01-27 10:22:00
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Cited by:
  1. Jorge Alonso-Ortiz & Richard Rogerson, 2010. "Taxes, transfers, and employment in an incomplete markets model," CQER Working Paper, Federal Reserve Bank of Atlanta 2010-07, Federal Reserve Bank of Atlanta.
  2. Michael P. Keane & Richard Rogerson, 2011. "Reconciling Micro and Macro Labor Supply Elasticities: A Structural Perspective," NBER Working Papers 17430, National Bureau of Economic Research, Inc.
  3. Richard Rogerson, 2011. "Individual and Aggregate Labor Supply with Coordinated Working Times," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 43, pages 7-37, 08.
  4. Yongsung Chang & Sun-Bin Kim & Frank Schorfheide, 2010. "Labor-Market Heterogeneity, Aggregation, and the Lucas Critique," NBER Working Papers 16401, National Bureau of Economic Research, Inc.

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