Macroeconomics with Heterogeneity: A Practical Guide

Abstract

This article reviews macroeconomic models with heterogeneous households. A key question for the relevance of these models concerns the degree to which markets are complete. This is because the existence of complete markets imposes restrictions on (i) how much heterogeneity matters for aggregate phenomena and (ii) the types of cross-sectional distributions that can be obtained. The degree of market incompleteness, in turn, depends on two factors: (i) the richness of insurance opportunities provided by the economic environment and (ii) the nature and magnitude of idiosyncratic risks to be insured. First, I review a broad collection of empirical evidence-from econometric tests of "full insurance," to quantitative and empirical analyses of the permanent income ("self-insurance") model that examine how it fits the facts about life cycle allocations, to studies that try to directly measure where economies place between these two benchmarks ("partial insurance"). The empirical evidence I survey reveals significant uncertainty in the profession regarding the magnitudes of idiosyncratic risks as well as whether or not these risks have increased since the 1970s. An important difficulty stems from the fact that inequality often arises from a mixture of idiosyncratic risk and fixed (or predictable) heterogeneity, making the two challenging to disentangle. I also discuss applications of incomplete markets models to trends in wealth, consumption, and earnings inequality both over the life cycle and over time, where this challenge is evident. Third, I discuss "approximate" aggregation-the finding that some incomplete markets models generate aggregate implications very similar to representative-agent models. What approximate aggregation does and does not imply is illustrated through several examples. Finally, I discuss some computational issues relevant for solving and calibrating such models and I provide a simple yet fully parallelizable global optimization algorithm that can be used to calibrate heterogeneous agent models.

Macroeconomics and Household Heterogeneity

“…Faced with the elevated chance of becoming unemployed, impatient households who have not yet lost their jobsand have currently medium to high income realizations start to save more for precautionary reasons. 60 For more patient employed households, the increase in precautionary saving and resulting drop in consumption at the onset of the recession is not quite as severe. These households were already saving a larger fraction of their income even in good times, since their patience makes them more focused on the long horizon.…”

“…Also, not unexpectedly, among impatient households wealth levels tend to be lower, as the groupspecific wealth distributions underneath the consumption functions in figure 9 show. As a broad summary measure of this differential effect, the contribution to the aggre- 60 The small share of impatient, low-wealth households that do in fact lose their jobs at the onset of the recession behave like hand-to-mouth consumers instead, cutting their consumption one for one with income, and consume whatever little wealth they might have at the beginning of the recession.…”

Macroeconomics with Financial Frictions: A Survey

“…so the marginal value of transferring one unit of consumption from period t to period 21 For a detailed survey on the effects of heterogeneity in macroeconomics see Guvenen (2012).…”

Incentive Compatibility as a Nonnegative Martingale

“…Note that while there does not exist a representative agent in the aggregate for our friction-loaded economy in competitive equilibrium, there does exist one in the first-best (a frictionless or complete markets) economy; see Guvenen (2011). Later, we expose the relation between the intertemporal individual wedge implied by the IEE and the optimal intertemporal aggregate wedge according to (22).…”