Saturday, September 11, 2010

When assumptions drive the result

I have spent the past few days at the Wisconsin-St Louis Fed conference on Housing, Urban, Labor and Macroeconomics; it is a third in a series that Morris Davis had organized, and the papers were thought-provoking and well done.

The macro paper, however, was about whether government can effectively counteract negative shocks to one sector of the economy. To the standard macro model it added a friction where workers had to retrain in the event of a shock to one sector of the economy so as to be able to work in another sector. This is clever and important.

But while the model allowed for frictions, it failed to allow for involuntary unemployment, and so it found that government interventions were ineffective. Well, duh...


Morris said...

It's hard to do involuntary unemployment when you have a representative agent model.

Basically you can use a trick of indivisible labor (think 9am - 5pm) with a "lottery" to see who gets unemployed.

Agreed this area needs a lot more work. I'm glad though that we're thinking about what governments can/should do in response to big shocks. Think of this as the theoretical side to explain/justify the empirical multipliers.

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