Journal of Economic Perspectives—Volume 10, Number 1—Winter 1996—Pages 87-104
The Empirical Foundations of Calibration
Lars Peter Hansen and James J. Heckman
General equilibrium theory provides the intellectual underpinnings for modern macroeconomics, finance, urban economics, public finance and numerous other fields. However, as a paradigm for organizing and synthesizing economic data, it poses some arduous challenges. A widely accepted empirical counterpart to general equilibrium theory remains to be developed. There are few testable implications of general equilibrium theory for a time series of aggregate quantities and prices. There are a variety of ways to formalize this claim. Sonnenschein (1973) and Mantel (1974) show that excess aggregate demand functions can have “arbitrary shapes” as long as Walras’ Law is satisfied. Similarly, Harrison and Kreps (1979) show that a competitive equilibria can always be constructed to rationalize any arbitrage-free specification of prices. Observational equivalence results are pervasive in economics. There are two responses to this state of affairs. One can view the flexibility of the general equilibrium paradigm as its virtue. Since it is hard to reject, it provides a rich apparatus for interpreting and processing data. 1 Alternatively, general equilibrium theory can be dismissed as being empirically irrelevant because it imposes no testable restrictions on market data.
Even if we view the “flexibility” of the general equilibrium paradigm as a virtue, identification of preferences and technology is problematic. Concern about the
1 Lucas and Sargent (1988) make this point in arguing that early Keynesian critiques of classical economics were misguided by their failure to recognize this flexibility.
■ Lars Peter Hansen is Homer J. Livingston Professor of Economics, and James Heckman is Henry Schultz Distinguished Service Professor of Economics and Director of the Center for Social Program Evaluation at the Irving B. Harris School of Public Policy Studies, all at the University of Chicago, Chicago, Illinois.