Dynamic Cross Sections and Heterogeneity in Macroeconomics

Project Information

DCS

Grant agreement ID: 101054421

DOI

10.3030/101054421

EC signature date 19 May 2022

Start date 1 October 2022

End date 30 September 2027

Funded under

• European Research Council (ERC)

Total cost

€ 1 447 893,00

EU contribution

€ 1 447 893,00

Coordinated by

LUISS LIBERA UNIVERSITA INTERNAZIONALE DEGLI STUDI SOCIALI GUIDO CARLI
Italy

Periodic Reporting for period 1 - DCS (Dynamic Cross Sections and Heterogeneity in Macroeconomics)

Reporting period: 2022-10-01 to 2025-03-31

Summary of the context and overall objectives of the project

The project addresses a key challenge in modern macroeconomics: understanding the implications of substantial heterogeneity among households and firms, a feature largely ignored in representative-agent models. This heterogeneity is crucial for explaining economic behavior and the response to shocks, particularly in the presence of frictions and lumpy adjustments (e.g. investment decisions, technology adoption, pricing).
DCS goal is to develop new methods for characterizing equilibrium dynamics in economies with realistic distributions of agents. The project focuses on two major applications:
1. Understanding macroeconomic responses to shocks by identifying and quantifying frictions in models with lumpy behavior.
2. Analyzing dynamic strategic complementarities and network effects, where individual decisions depend on others' behavior (e.g. firms or consumers adopting new technologies based on peer decisions).
The project integrates social science disciplines such as behavioral microeconomics and game theory to model strategic interactions. The expected impact includes better tools for macroeconomic analysis and improved models to inform economic policy.

Work performed from the beginning of the project to the end of the period covered by the report and main results achieved so far

The project delivered several theoretical and empirical contributions:
1. Sticky Prices and Sufficient Statistics: A key result shows that the persistence of aggregate responses to nominal shocks is captured by a single observable statistic: the ratio of kurtosis to frequency (K/F) of price changes. An empirical test using French microdata (Alvarez et al.) confirms this result, showing a strong correlation between K/F and price non-neutrality. This work, forthcoming in Review of Economic Studies, supports the statistic’s validity in actual economies.
2. Large Shocks and Fast Price Adjustments: In collaboration with Cavallo and Miyahara (AER: Insights, forthcoming), the project shows that firms adjust prices more rapidly after large shocks, such as the 2022 energy price surge. Using a New Keynesian model calibrated to pre-shock data, the study demonstrates the presence of "state dependence"—firms are more likely to change prices when markups are misaligned. These results have important implications for inflation forecasting and call into question the Calvo pricing models often used by central banks.
3. Dynamic Strategic Complementarities: With Alvarez and Souganidis (Econometrica, 2023), a new analytic framework was developed to study general equilibrium in models with strategic complementarities in price-setting. By adapting perturbation techniques from physics, the paper shows that complementarities can significantly amplify the impact of nominal shocks. As the degree of complementarity increases, impulse responses grow convexly, potentially destabilizing equilibrium.

Progress beyond the state of the art and expected potential impact (including the socio-economic impact and the wider societal implications of the project so far)

The methods developed, especially for analyzing dynamic complementarities, can be extended to other areas of macroeconomics. One promising application is the diffusion of new technologies, such as Central Bank Digital Currencies (CBDCs), where network effects are central: the benefit of adoption depends on how widely the technology is used.
Potential Impact and Future Directions:
-Theoretical tools applicable across various macroeconomic domains.
-Empirical insights that improve understanding of how economies respond to shocks.
-Direct implications for central bank models and policy design.
To maximize uptake and long-term impact, the project identifies key next steps:
-Continued empirical testing in broader contexts.
-Dissemination to policymakers (e.g. presentation at the ECB Sintra conference).
-Application to financial markets and technological diffusion.
-Consideration of supportive regulation and data-sharing for further experimentation.
Key Publications (ERC Acknowledged)
Cavallo, Lippi, Miyahara – Large shocks travel fast, AER: Insights, forthcoming
Alvarez et al. – Empirical Investigation of a Sufficient Statistic, Review of Economic Studies, forthcoming
Alvarez, Lippi, Souganidis – Caballero-Engel meet Lasry-Lions, Mathematics and Financial Economics, 2024
Alvarez, Lippi, Souganidis – Price Setting with Strategic Complementarities as a Mean Field Game, Econometrica, 2023
Calvia et al. – A simple planning problem for COVID-19 lockdown, Economic Theory, 2024
Lippi, Perri – Unequal Growth, Journal of Monetary Economics, 2023