The purpose of the proposal is to continue an ongoing research effort - developing theory and empirical methods - aiming to better understand the interplay between macroeconomics and inequality. Earlier work of the investigators has analyzed macroeconomic models with a cross-section of consumers, with an accompanying nontrivial determination of the wealth distribution and of individual wealth transitions. This endeavor, which this project continues, is motivated both by (i) the need to build more solid microfoundations for existing macroeconomic models"consumer heterogeneity is a fact of arguably first-order importance" and by (ii) an interest per se in inequality, and in how macroeconomic aggregates and macroeconomic policy influence the cross-section of consumers. An overall goal of the present proposal is to extend macroeconomic theory and methods so as to establish a closer, and more solid, connection with the applied microeconomic literatures studying consumption and labor supply decisions; thus, it is closely in line with the goals stated, not from the perspective of macroeconomics, but from the perspective of microeconomics.
A key insight in the earlier work of the PIs is approximate aggregation: a feature of theoretical economies with heterogeneous agents that (i) allows these economies to be analyzed at all (otherwise they may be infeasibly complicated) and (ii) at the same time opens up the possibility of exploring new macroeconomic models, with substantial and realistic consumer heterogeneity, that have nontrivial and interesting properties that seem to be able to help us understand the data better. The current proposal contains four main components that are part of the same overall goal. First, the aim is to continue exploring the boundaries of approximate aggregation: systematically looking for economically interesting cases where approximate aggregation may fail. In particular, the project explores new forms of heterogeneity that are a priori interesting and studies nonstationary macroeconomic episodes (involving, say, large policy change or a burst of technological progress). Second, the investigators look specifically at a form of heterogeneity that has had very little presence in macroeconomic analyses but that is arguably key especially in asset markets and for investment decisions: asymmetric information (about fundamentals). This part of the research imports insights from financial economics and adapts them to an otherwise standard, quantitative macroeconomic setting, which presumes that all investors have the same beliefs. Third, the project examines frictions in the labor market. Specifically, it will go underneath the exogenous idiosyncratic income processes used in earlier work by explicitly modeling a labor market with frictions and then incorporating this market into the macroeconomic model. It will also develop richer ways to capture empirically the multiple sources of income risk that households face. Fourth and finally, the project explores the econometrics of bringing the macroeconomic model with heterogeneity to the data; here, the methodological development includes combining model solution and parameter choice. The intellectual merit of the proposed activity is thus the development of advanced tools for improving the analysis both of the macroeconomy and of inequality in the context of the macroeconomy.
The broader impacts resulting from the proposed activity are central: they aim to connect macroeconomic analysis, in a substantial way, to other disciplines within economics, primarily applied microeconomics. In addition, the development of tools here"in part for computation" is broadly useful in economic analysis. Finally, and most broadly, much of the public debate about macroeconomic policy focuses on its distributional effects, on who gains and who loses from changes in policy. The proposed research seeks precisely to improve the ability of economists to assess the quantitative effects of policy on different groups the rich and the poor, the skilled and the unskilled, the employed and the unemployed within the macroeconomy. The proposed research, if successful, will ultimately help policymakers to make more informed decisions.
