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Macroeconomic Volatility In General Equilibrium

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  • Warwick J McKibbin

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  • Peter J Wilcoxen

Abstract

In this paper we explore the concept of excess volatility in general equilibrium. We show there is a fundamental tension between household efforts to smooth consumption and attempts by firms’ to smooth investment in the presence of convex adjustment costs in capital formation. Adjustment costs substantially diminish the ability of households to smooth consumption. As a result, consumption volatility will be significantly higher in the presence of adjustment costs than would be expected from the permanent income model alone. Moreover adjustment costs can cause consumption and asset prices to change discontinuously at the moment of implementation of a previously anticipated event, a phenomenon that does not occur in models without adjustment costs.

Suggested Citation

  • Warwick J McKibbin & Peter J Wilcoxen, 1997. "Macroeconomic Volatility In General Equilibrium," Departmental Working Papers 1998-07, The Australian National University, Arndt-Corden Department of Economics, revised Jun 1998.
  • Handle: RePEc:pas:papers:1998-07
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    File URL: https://crawford.anu.edu.au/acde/publications/publish/papers/wp1998/bdp1401.pdf
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    References listed on IDEAS

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    Cited by:

    1. McKibbin, Warwick J. & Tan, Kang Yong, 2009. "Learning and international transmission of shocks," Economic Modelling, Elsevier, vol. 26(5), pages 1033-1052, September.
    2. Pratt, Stephen & Blake, Adam & Swann, Peter, 2013. "Dynamic general equilibrium model with uncertainty: Uncertainty regarding the future path of the economy," Economic Modelling, Elsevier, vol. 32(C), pages 429-439.
    3. Lecca, Patrizio & McGregor, Peter G. & Swales, J. Kim, 2013. "Forward-looking and myopic regional Computable General Equilibrium models: How significant is the distinction?," Economic Modelling, Elsevier, vol. 31(C), pages 160-176.

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