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Partial Adjustment without Apology

  • Robert G. King

    ()

    (Department of Economics, Boston University)

  • Julia K. Thomas

    ()

    (Department of Economics, University of Minnesota)

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 facing fixed costs of factor adjustment. In the market equilibrium of this model, employment responses to aggregate disturbances include changes both in a target employment selected by establishments and in the measure of establishments actively adjusting to this target. Yet the model retains a partial adjustment flavor in its aggregate responses. Previous research involving discrete factor adjustment has been conducted almost exclusively under the assumption of exogenous prices, given the complications presented by nontrivial heterogeneity in production. We demonstrate how such complications can be limited, allowing both general equilibrium analysis and the convenience of linear solution methods. We also show how our framework is easily generalized to accommodate persistent idiosyncratic shocks. This generalization allows both greater consistency with the microeconomic dynamics of factor adjustment, as well as application to a much broader set of questions involving discrete individual choices, within a tractable equilibrium model.

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Paper provided by Boston University - Department of Economics in its series Boston University - Department of Economics - Macroeconomics Working Papers Series with number WP2005-001.

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Length: 39 pages
Date of creation: Feb 2005
Date of revision:
Publication status: Forthcoming in International Economic Review
Handle: RePEc:bos:macppr:wp2005-001
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Web page: http://www.bu.edu/econ/

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  1. Lucas, Robert E, Jr & Prescott, Edward C, 1971. "Investment Under Uncertainty," Econometrica, Econometric Society, vol. 39(5), pages 659-81, September.
  2. 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.
  3. Hamermesh, Daniel S. & Pfann, Gerard Antonie, 1996. "Adjustment Costs in Factor Demand," CEPR Discussion Papers 1371, C.E.P.R. Discussion Papers.
  4. Daniel S. Hamermesh, 1990. "Aggregate Employment Dynamcis and Lumpy Adjustment Costs," NBER Working Papers 3229, National Bureau of Economic Research, Inc.
  5. Kennan, John, 1979. "The Estimation of Partial Adjustment Models with Rational Expectations," Econometrica, Econometric Society, vol. 47(6), pages 1441-55, November.
  6. King, Robert G. & Rebelo, Sergio T., 1999. "Resuscitating real business cycles," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 14, pages 927-1007 Elsevier.
  7. Caballero, R.J., 1994. "Explaining Investment Dynamics in U.S. Manufacturing: Generalized (S,s) Approach," Working papers 94-32, Massachusetts Institute of Technology (MIT), Department of Economics.
  8. Julia K. Thomas, . "Is Lumpy Investment Relevant for the Business Cycle?," GSIA Working Papers 1998-E250, Carnegie Mellon University, Tepper School of Business.
  9. 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.
  10. Aubhik Khan & Julia K. Thomas, . "Nonconvex Factor Adjustments in Equilibrium Business Cycle Models: Do Nonlinearities Matter?," GSIA Working Papers 2000-E33, Carnegie Mellon University, Tepper School of Business.
  11. Daniel S. Hamermesh, 1988. "Labor Demand and the Structure of Adjustment Costs," NBER Working Papers 2572, National Bureau of Economic Research, Inc.
  12. Caballero, Ricardo J & Engel, Eduardo M R A & Haltiwanger, John, 1997. "Aggregate Employment Dynamics: Building from Microeconomic Evidence," American Economic Review, American Economic Association, vol. 87(1), pages 115-37, March.
  13. Kollintzas, Tryphon, 1985. "The Symmetric Linear Rational Expectations Model," Econometrica, Econometric Society, vol. 53(4), pages 963-76, July.
  14. 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.
  15. Sargent, Thomas J, 1978. "Estimation of Dynamic Labor Demand Schedules under Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 1009-44, December.
  16. Mortensen, Dale T, 1973. "Generalized Costs of Adjustment and Dynamic Factor Demand Theory," Econometrica, Econometric Society, vol. 41(4), pages 657-65, July.
  17. 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.
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