A Note on Aggregation and the Lucas Critique

Michael Reiter

Bulletin of Economic Research, 1998, vol. 50, issue 4, 309-21

Abstract: 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. Copyright 1998 by Blackwell Publishing Ltd and the Board of Trustees of the Bulletin of Economic Research

Date: 1998
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