Microeconomic Heterogeneity and Macroeconomic Shocks

This essay analyzes the role of household heterogeneity for how the macroeconomy responds to aggregate shocks. After reviewing how quantitative macroeconomics incorporated household heterogeneity and market incompleteness over roughly three decades – work that, the authors argue, has been mostly confined to inequality and redistribution questions rather than business cycles, partly because of computational complexity and partly because of a widespread but “inaccurate” reading of Krusell and Smith’s (1998) “approximate aggregation” result as showing heterogeneous- and representative-agent dynamics are essentially the same – the paper outlines an emerging Heterogeneous Agent New Keynesian (HANK) framework, built on Kaplan, Moll, and Violante (2018), that gives households access to both a low-return liquid asset and a high-return illiquid asset subject to a transaction cost. Simulating a consistently calibrated HANK model against its representative-agent (RANK) counterpart, the authors introduce a three-way taxonomy of “strong,” “weak,” and “non-equivalence” between the two frameworks and show, through a discount-factor (demand) shock, a total-factor-productivity shock, a monetary policy shock, and government spending and transfer shocks, that the degree of equivalence depends entirely on which shock is analyzed: demand shocks are strongly equivalent, TFP shocks produce similar aggregate paths through different mechanisms, and monetary and fiscal shocks generate starkly different aggregate responses because HANK consumption is far more sensitive to current disposable income and far less sensitive to interest-rate changes than RANK consumption. The paper’s second message is that heterogeneous-agent models open up macroeconomic questions that representative-agent models cannot even pose – microfounding a fall in aggregate demand through tighter credit limits or higher idiosyncratic income risk, using the cross-sectional pattern of a shock’s transmission to help identify its source, and studying how aggregate shocks and stabilization policy reshape household inequality – and it closes by naming seven directions (real wage and product-market frictions, labor-market microfoundations, gross and nominal balance sheets, time-varying risk premia, financial intermediaries, non-rational-expectations, and optimal policy) along which the still-“infant” HANK framework needs further development.

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Microeconomic Heterogeneity and Macroeconomic Shocks