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Partial Adjustment Without Apology

Staff Report 327 | Published August 1, 2004

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Partial Adjustment Without Apology


Many kinds of economic behavior involve discrete and occasional individual choices. Despite this, econometric partial adjustment models perform relatively well at the aggregate level. Analyzing the classic employment adjustment problem, we show how such microeconomic adjustment is well described by a new form of partial adjustment model that aggregates the actions of heterogeneous producers. We develop a model where individual establishments infrequently alter the sizes of their workforces because such adjustments involve fixed costs. In the market equilibrium, employment responses to aggregate disturbances include changes both in target employments selected by individual establishments and in the measure of establishments actively undertaking adjustment. Yet the model retains a partial adjustment flavor in its aggregate responses. Moreover, in contrast to existing discrete adjustment models, our generalized partial adjustment model is sufficiently tractable to allow general equilibrium analysis, and it naturally extends to accommodate persistent differences in productivity across establishments in general equilibrium.

Published in: _International Economic Review_ (Vol. 47, Issue 3, August 2006, pp. 779-809)