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A Note on Aggregation and the Lucas Critique[Note 1. I gratefully acknowledge the very helpful comments of two ...]
Author(s) -
Reiter Michael
Publication year - 1998
Publication title -
bulletin of economic research
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.227
H-Index - 29
eISSN - 1467-8586
pISSN - 0307-3378
DOI - 10.1111/1467-8586.00067
Subject(s) - economics , aggregate (composite) , permanent income hypothesis , rational expectations , consumption (sociology) , competitor analysis , econometrics , simple (philosophy) , consumption function , mathematical economics , economic model , microeconomics , macroeconomics , production (economics) , social science , philosophy , materials science , management , epistemology , sociology , market liquidity , composite material
The paper investigates the effects of aggregation on different macroeconomic modelling strategies. This is done within the framework of a small example economy, where all households solve the same intertemporal consumption problem, but with different parameters of the utility functions and different exogenous income processes. Three models are fitted to the aggregate data: a representative agent rational expectations model, a simple version of the permanent income hypothesis, and a time series model. If the economic environment is kept stable, the three approaches perform similarly well. However, the representative agent model stands up to the Lucas critique better than its competitors, despite the aggregation error. Unlike the other models, it never gives completely wrong forecasts even after an exogenous change in income processes.