Michael Reiter, Universitat Pompeu Fabra, Barcelona
A Note on Aggregation and the Lucas Critique
August 1996 -- revised March 1998
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 their 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.