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Labor-Market Heterogeneity, Aggregation, and the Lucas Critique

  • Chang, Yongsung
  • Schorfheide, Frank

This paper assesses biases in policy predictions due to the lack of invariance of ``structural'' parameters in representative-agent models. We simulate data under various fiscal policy regimes from a heterogeneous-agents economy with incomplete asset markets and indivisible labor supply. Imperfect aggregation manifests itself through preference shocks in the estimated representative-agent model. Preference and technology parameter estimates are not invariant with respect to policy changes. As a result, the bias in the representative-agent model's policy predictions is large compared to the length of predictive intervals that reflect parameter uncertainty.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8039.

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Date of creation: Oct 2010
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Handle: RePEc:cpr:ceprdp:8039
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