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The Krusell–Smith Algorithm: Are Self-Fulfilling Equilibria Likely?

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  • Marco Cozzi

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Abstract

I investigate whether the popular Krusell and Smith algorithm used to solve heterogeneous-agent economies with aggregate uncertainty and incomplete markets is likely to be subject to multiple self-fulfilling equilibria. In a benchmark economy, the parameters representing the equilibrium aggregate law of motion are randomly perturbed 500 times, and are used as the new initial guess to compute the equilibrium with this algorithm. In a sequence of cases, differing only in the magnitude of the perturbations, I do not find evidence of multiple self-fulfilling equilibria. The economic reason behind the result lies in a self-correcting mechanism present in the algorithm: compared to the equilibrium law of motion, a candidate one implying a higher (lower) expected future capital reduces (increases) the equilibrium interest rates, increasing (reducing) the savings of the wealth-rich agents only. These, on the other hand, account for a small fraction of the population and cannot compensate for the opposite change triggered by the wealth-poor agents, who enjoy higher (lower) future wages and increase (reduce) their current consumption. Quantitatively, the change in behavior of the wealth-rich agents has a negligible impact on the determination of the change in the aggregate savings, inducing stability in the algorithm as a by-product. Copyright Springer Science+Business Media New York 2015

Suggested Citation

  • Marco Cozzi, 2015. "The Krusell–Smith Algorithm: Are Self-Fulfilling Equilibria Likely?," Computational Economics, Springer;Society for Computational Economics, vol. 46(4), pages 653-670, December.
  • Handle: RePEc:kap:compec:v:46:y:2015:i:4:p:653-670
    DOI: 10.1007/s10614-014-9470-7
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    Cited by:

    1. Marco Cozzi, 2014. "Heterogeneity in Macroeconomics and the Minimal Econometric Interpretation for Model Comparison," Working Papers 1333, Queen's University, Department of Economics.
    2. repec:eee:jmacro:v:53:y:2017:i:c:p:162-175 is not listed on IDEAS

    More about this item

    Keywords

    Unemployment risk; Business cycles; Incomplete markets; Heterogeneous agents; Numerical methods; Self-fulfilling equilibria; C63; C68; E21; E32;

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • C68 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computable General Equilibrium Models
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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