Dampening General Equilibrium: From Micro Elasticities to Macro Effects

Chen Lian and George-Marios Angeletos
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Chen Lian: MIT

No 1456, 2016 Meeting Papers from Society for Economic Dynamics

Abstract: General equilibrium (GE) effects are key to macroeconomics: they turn partial-equilibrium intuitions on their head; they also limit the use- fulness of identifying local responses to local shocks as a method of es- timating the macroeconomic effects of aggregate shocks. In this paper, we argue that GE effects are weak in the short run. In particular, we establish an equivalence between (i) the Tâtonnement process of a stan- dard macroeconomic model and (ii) the equilibrium dynamics of a variant model that removes common knowledge of aggregate economic conditions. This offers a formalization of the notion that GE adjustments take time; it provides a justification for extrapolating from the aforementioned kind of micro elasticities to macro effects; and it upsets conventional policy recommendations.

Date: 2016
New Economics Papers: this item is included in nep-dge and nep-mac
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