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Labor-Market Heterogeneity, Aggregation, and the Lucas Critique

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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File URL: http://rcer.econ.rochester.edu/RCERPAPERS/rcer_556.pdf
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Paper provided by University of Rochester - Center for Economic Research (RCER) in its series RCER Working Papers with number 556.

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Length: 50 pages
Date of creation: Sep 2010
Date of revision:
Handle: RePEc:roc:rocher:556
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University of Rochester, Center for Economic Research, Department of Economics, Harkness 231 Rochester, New York 14627 U.S.A.

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