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Deep Structral Excavation? A Critique of Euler Equation Methods

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  • Peter M. Garber
  • Robert G. King

Abstract

Rational expectations theory instructs empirical researchers to uncover the values of 'deep' structural parameters of preferences and technology rather than the parameters of decision rules that confound these structural parameters with those of forecasting equations. This paper reevaluates one method of identifying and estimating such deep parameters, recently advanced by Hansen and Singleton, that uses intertemporal efficiency expressions (Euler equations) and basic properties of expectations to produce orthogonality conditions that permit parameter estimation and hypothesis testing. These methods promise the applied researcher substantial freedom, as it is apparently not necessary to specify the details of dynamic general equilibrium to study the behavior of a particular market participant. In this paper, we demonstrate that this freedom is illusory. That is, if there are shifts in agents' objectives which are not directly observed by the econometrician, then Euler equation methods encounter serious identification and estimation difficulties. For these difficulties to be overcome the econometrician must have prior knowledge concerning variables that are exogenous to the agent under study, as in conventional simultaneous equations theory.

Suggested Citation

  • Peter M. Garber & Robert G. King, 1983. "Deep Structral Excavation? A Critique of Euler Equation Methods," NBER Technical Working Papers 0031, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberte:0031
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    1. Miron, Jeffrey A & Zeldes, Stephen P, 1988. "Seasonality, Cost Shocks, and the Production Smoothing Models of Inventories," Econometrica, Econometric Society, vol. 56(4), pages 877-908, July.
    2. Shapiro, Matthew D, 1986. "Capital Utilization and Capital Accumulation: Theory and Evidence," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 1(3), pages 211-234, July.
    3. Ogaki, Masao & Park, Joon Y., 1997. "A cointegration approach to estimating preference parameters," Journal of Econometrics, Elsevier, vol. 82(1), pages 107-134.
    4. Robert J. Shiller, 1987. "Ultimate Sources of Aggregate Variability," Cowles Foundation Discussion Papers 816, Cowles Foundation for Research in Economics, Yale University.
    5. Urban J. Jermann & Marianne Baxter, 1999. "Household Production and the Excess Sensitivity of Consumption to Current Income," American Economic Review, American Economic Association, vol. 89(4), pages 902-920, September.
    6. Matthew D. Shapiro, 1986. "The Dynamic Demand for Capital and Labor," The Quarterly Journal of Economics, Oxford University Press, vol. 101(3), pages 513-542.
    7. Charlotta Groth & Hashmat Khan, 2010. "Investment Adjustment Costs: An Empirical Assessment," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(8), pages 1469-1494, December.
    8. Amano, Robert A. & Wirjanto, Tony S., 1996. "Intertemporal substitution, imports and the permanent income model," Journal of International Economics, Elsevier, vol. 40(3-4), pages 439-457, May.
    9. Robert J. Gordon & John Veitch, 1986. "Fixed Investment in the American Business Cycle, 1919-83," NBER Chapters, in: The American Business Cycle: Continuity and Change, pages 267-358, National Bureau of Economic Research, Inc.
    10. Eichenbaum, Martin, 1989. "Some Empirical Evidence on the Production Level and Production Cost Smoothing Models of Inventory Investment," American Economic Review, American Economic Association, vol. 79(4), pages 853-864, September.
    11. Robert E. Hall, 1987. "Consumption," NBER Working Papers 2265, National Bureau of Economic Research, Inc.
    12. Robert E. Hall, 1986. "The Role of Consumption in Economic Fluctuations," NBER Chapters, in: The American Business Cycle: Continuity and Change, pages 237-266, National Bureau of Economic Research, Inc.
    13. Charlotta Groth & Hashmat Khan, 2007. "Investment adjustment costs: evidence from UK and US industries," Bank of England working papers 332, Bank of England.
    14. Stevens, Guy V. G. & Lipsey, Robert E., 1992. "Interactions between domestic and foreign investment," Journal of International Money and Finance, Elsevier, vol. 11(1), pages 40-62, February.
    15. Miron, Jeffrey A, 1986. "Seasonal Fluctuations and the Life Cycle-Permanent Income Model of Consumption," Journal of Political Economy, University of Chicago Press, vol. 94(6), pages 1258-1279, December.
    16. Robert E. Hall, 2002. "Industry Dynamics with Adjustment Costs," NBER Working Papers 8849, National Bureau of Economic Research, Inc.
    17. Shin-Ichi Nishiyama & Masao Ogaki, 2011. "The Cross-Euler Equation Approach in Estimating the Elasticity of Intertemporal Substitution for Food and Non-Food Consumption in Japan," TERG Discussion Papers 275, Graduate School of Economics and Management, Tohoku University.
    18. Marjorie A. Flavin, 1991. "The Joint Consumption/Asset Demand Decision: A Case Study in Robust Estimation," NBER Working Papers 3802, National Bureau of Economic Research, Inc.
    19. Oliner, Stephen D. & Rudebusch, Glenn D. & Sichel, Daniel, 1996. "The Lucas critique revisited assessing the stability of empirical Euler equations for investment," Journal of Econometrics, Elsevier, vol. 70(1), pages 291-316, January.
    20. Chirinko, Robert S., 1995. "Nonconvexities, labor hoarding, technology shocks, and procyclical productivity a structural econometric analysis," Journal of Econometrics, Elsevier, vol. 66(1-2), pages 61-98.
    21. Ciaran Driver & Paul Temple & Giovanni Urga, 2005. "Contrasts Between Classes of Assets in Fixed Investment Equations as a Way of Testing Real Option Theory," School of Economics Discussion Papers 0805, School of Economics, University of Surrey.
    22. Charlotta Groth, 2005. "Estimating UK capital adjustment costs," Bank of England working papers 258, Bank of England.
    23. Joao F. Gomes, 2001. "Financing Investment," American Economic Review, American Economic Association, vol. 91(5), pages 1263-1285, December.
    24. William P. Osterberg, 1992. "Debt, collateral, and U.S. manufacturing investment: 1954-1980," Working Papers (Old Series) 9210, Federal Reserve Bank of Cleveland.
    25. Charlotta Groth, 2008. "Quantifying UK Capital Adjustment Costs," Economica, London School of Economics and Political Science, vol. 75(298), pages 310-325, May.

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