Three Strikes and You.re Out: Reply to Cooper and Willis

Three Strikes and You’re Out: Reply to Cooper and Willis

Ricardo J. Caballero and Eduardo M.R.A. Engel

Abstract

Cooper and Willis (2003) is the latest in a sequence of criticisms of our methodology for
estimating aggregate nonlinearities when microeconomic adjustment is lumpy. Their case is based
on “reproducing” our main findings using artificial data generated by a model where microeconomic
agents face quadratic adjustment costs. That is, they supposedly find our results where they should
not be found. The three claims on which they base their case are incorrect. Their mistakes range
from misinterpreting their own simulation results to failing to understand the context in which our
procedures should be applied. They also claim that our approach assumes that employment
decisions depend on the gap between the target and current level of unemployment. This is incorrect
as well, since the ‘gap approach’ has been derived formally from at least as sophisticated
microeconomic models as the one they present. On a more positive note, the correct interpretation
of Cooper and Willis’s results shows that our procedures are surprisingly robust to significant
departures from the assumptions made in our original derivations.

Keywords: Adjustment hazard, aggregate nonlinearities, lumpy adjustment, observed and
unobserved gaps, quadratic adjustment.

JEL Codes: E2, J2, J6.

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