COWLES FOUNDATION FOR RESEARCH IN
ECONOMICS Box 208281
COWLES FOUNDATION DISCUSSION PAPER NO. 1430 Missing Aggregate Dynamics: Ricardo J. Caballero and Eduardo M.R.A. Engel July 2003 The dynamic response of aggregate variables to shocks is one of the
central concerns of applied macroeconomics. The main measurement procedure for these
dynamics consists of estimating an ARMA or VAR (VARs, for short). In non- or
semi-structural approaches, the characterization of dynamics stops there. In other, more
structural approaches, researcher try to uncover underlying adjustment cost parameters
from the estimated VARs. Yet, in others, such as in RBC models, these estimates are used
as the benchmark over which the success of the calibration exercise, and the need for
further theorizing, is assessed. The main point of this paper is that when the
microeconomic adjustment underlying the corresponding aggregates is lumpy, conventional
VARs procedures are often inadequate for all of the above practices. In particular, the
researcher will conclude that there is less persistence in the response of aggregate
variables to aggregate shocks than there really is. Paradoxically, while idiosyncratic
productivity and demand shocks smooth away microeconomic non-convexities and are often
used as a justification for approximating aggregate dynamics with linear models, their
presence exacerbate the bias. Since in practice idiosyncratic uncertainty is many times
larger than aggregate uncertainty, we conclude that the problem of missing aggregate
dynamics is prevalent in empirical and quantitative macroeconomic research. |
