Missing Internal Propagation in Macro Models

Abstract

This paper identifies a key challenge in medium-scale DSGE models. These models tend to produce investment volatility nearly 100 times larger than what is observed in the data. This issue arises when we force these models to match both business cycle and long-run variance of ‘hours worked’. To address this problem, we develop a general equilibrium model where both wages and the rent on capital are determined by the present discounted values of the marginal product of labor (MPL) and the marginal product of capital (MPK), respectively. This model provides a solution to the documented empirical issue and highlights an important propagation mechanism in macroeconomic models.

Sanjay Moorjani

Contact - moorjani@bc.edu

My research interests include Macroeconomics and Monetary Economics.