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Dampening General Equilibrium: From Micro to Macro

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  • George-Marios Angeletos
  • Chen Lian

Abstract

We argue that standard modeling practices often overstate the potency of general-equilibrium (GE) mechanisms. We formalize the notion that GE adjustment is weak, or that it takes time, by modifying an elementary Walrasian economy in two alternative manners. In one, we replace Rational Expectations Equilibrium with solution concepts that mimic Tâtonnement or Cobweb dynamics, Level-k Thinking, Reflective Equilibrium, and certain kinds of cognitive discounting. In the other, we maintain rational expectations but remove common knowledge of aggregate shocks and accommodate higher-order uncertainty. This permits us, not only to illustrate the broader plausibility of the notion that the GE adjustment may be weak or slow, but also to illustrate the sense in which our preferred approach—the one based on lack of common knowledge—can be seen as a disciplined substitute to certain kinds of bounded rationality. We finally discuss possible applications, including how our results may help reduce the gap between the macroeconomic effects of interest and the micro or local effects estimated in a growing empirical literature.

Suggested Citation

  • George-Marios Angeletos & Chen Lian, 2017. "Dampening General Equilibrium: From Micro to Macro," NBER Working Papers 23379, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:23379 Note: EFG ME PE
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    References listed on IDEAS

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    Cited by:

    1. Xavier Gabaix, 2017. "Behavioral Inattention," NBER Working Papers 24096, National Bureau of Economic Research, Inc.

    More about this item

    JEL classification:

    • B41 - Schools of Economic Thought and Methodology - - Economic Methodology - - - Economic Methodology
    • D50 - Microeconomics - - General Equilibrium and Disequilibrium - - - General
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • E03 - Macroeconomics and Monetary Economics - - General - - - Behavioral Macroeconomics
    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General

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