Equilibrium Dynamics with Microeconomic Frictions

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9730133 Leahy This project continues research begun under an earlier NSF grant on the macroeconomic implications of microeconomic frictions. The dynamics of variables such as prices, employment, investment, and consumption represent the core of business cycle analysis. In each case the smoothness of the aggregates masks the lumpy nature of the individual decisions that underlie them. Much progress has been made in the past decade in understanding the relationship between individual and aggregate dynamics in these markets. The main weakness is the lack of appreciation for equilibrium interactions in these settings. This project addresses this omission. The project consists of theoretical and empirical components. The theoretical contribution consists of a method of constructing equilibria in a model with lumpy adjustment. Equilibrium in these settings is complicated by the fact that the evolution of aggregates usually depends on the entire distribution of individual states. The approach in this project is to make natural approximations to the distributional dynamics that retain the essential economic interactions while making the construction of equilibria tractable. The empirical component is twofold. The first task is to test the validity of the approximation. The second task is to match the responses predicted by the model with those evident in the data. ??