In recent years more macroeconomists have begun

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Chapter 22 / Exercise 68
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of different ages, different levels of experience, and different levels of education) is useful. In recent years, more macroeconomists have begun building heterogeneous-agent models. (For a description of such models and how they are developed, see José-Víctor Ríos-Rull, “Models with Heterogeneous Agents, ” in Thomas F. Cooley, ed., Frontiers of Business Cycle Research (Princeton: Princeton University Press, 1995), pp. 98–125.)Some researchers have used heterogeneous-agent models to study the costs of business cycles, in terms of the reduced well-being of the agents. In recessions, people who do not lose their jobs are not affected as much as people who lose their jobs; heterogeneous-agent models can account for the differential impact on the well-being of different people. In addition, people who lose their jobs may not be able to borrow, so their consumption spending declines, making them worse off. Research shows that when people cannot borrow, the costs of business cycles are significantly larger than if people were able to borrow whenever they lose their jobs, and thus not have to reduce their spending. Researchers have also used heterogeneous-agent models to see if they can calibrate the real interest rate better than in other models. The real interest rate generated by RBC models is often several percentage points higher than is true in the data. But in RBC models with heterogeneous agents in which people face risk, such as the risk of becoming unemployed, and cannot borrow if they become unemployed, then the real interest rate is somewhat lower than in other RBC models without heterogeneous agents. The risk in such models also leads people to save more than they would if there were no such risk.So, RBC models with heterogeneous agents are able to match certain aspects of the economic data better than standard RBC models.II.Money in the Classical Model (Sec. 10.2)A)Monetary policy and the economy Money is neutral in both the short run and the long run in the classical model, because prices adjust rapidly to restore equilibriumB)Monetary nonneutrality and reverse causation1.If money is neutral, why does the data show that money is a leading, procyclical variable?
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Chapter 22 / Exercise 68
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193Abel/Bernanke •Macroeconomics, Fifth Editiona.Increases in the money supply are often followed by increases in outputb.Reductions in the money supply are often followed by recessions2.The classical answer: Reverse causationa.Just because changes in money growth precede changes in output doesn’t mean that the money changes cause the output changesb.Example: People put storm windows on their houses before winter, but it’s the coming winter that causes the storm windows to go on, the storm windows don’t cause winterc.Reverse causation means money growth is higher because people expect higher output in the future; the higher money growth doesn’t cause the higher future outputd.If so, money can be procyclical and leading even though money is neutralData ApplicationA review of empirical work testing the RBCtheory of reverse causation is Shaghil Ahmed, “Does Money Affect Output?” Federal Reserve Bank of Philadelphia

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