Microeconomic Adjustment Hazards and Aggregate Dynamics

31 Pages Posted: 3 Jul 2007 Last revised: 5 Sep 2022

See all articles by Eduardo M. R. A. Engel

Eduardo M. R. A. Engel

Yale University - Department of Economics; National Bureau of Economic Research (NBER)

Ricardo J. Caballero

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: June 1992

Abstract

The basic premise of this paper is that understanding aggregate dynamics requires considering that agents are heterogeneous and that they do not adjust continuously to the shocks they perceive. We provide a general characterization of lumpy behavior at the microeconomic level in terms of an adjustment hazard function, that relates the probability that a unit adjusts to the deviation of its state variable from what would be its optimal level if frictions were momentarily removed. We argue that adjustment hazards that are eventually increasing with respect to the magnitude of this deviation are likely to be realistic. This allows for testable restrictions and a simple comparison with the partial adjustment model, which corresponds to the constant hazard case. We show how non-constant hazards - in particular, increasing hazards - generate non-linearities and history dependence in aggregate equations. We present an example based on U.S. Manufacturing employment and job flows, and find that increasing hazard models outperform partial adjustment models in describing aggregate employment dynamics; the improvement is most notorious during deep recessions and brisk expansions.

Suggested Citation

Engel, Eduardo M. and Caballero, Ricardo J., Microeconomic Adjustment Hazards and Aggregate Dynamics (June 1992). NBER Working Paper No. w4090, Available at SSRN: https://ssrn.com/abstract=476184

Eduardo M. Engel

Yale University - Department of Economics ( email )

28 Hillhouse Ave
New Haven, CT 06520-8268
United States
203-432-5595 (Phone)
203-432-5779 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Ricardo J. Caballero (Contact Author)

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

50 Memorial Drive
Building E52-528
Cambridge, MA 02142
United States
617-253-0489 (Phone)
617-253-1330 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States