Taking Stock
The material in this section is technical in nature and is useful for its applications more than for its own sake. At the level at which it has been presented here, it has widespread applications in macroeconomics and economic growth.
The stochastic neoclassical growth model, which we will see in the next chapter, makes heavy use of the methods developed here and is the workhorse model of modern macroeconomics.In addition to presenting the basic tools of stochastic dynamic programming, this chapter has presented two important economic models. The first, the stochastic permanent income hypothesis model is one of the most famous macroeconomic models and has led both to a large theoretical and empirical literature. The early empirical literature focused on excess sensitivity tests as discussed in subsection 16.5.1 using aggregate data. The more recent literature focuses on micro and panel data in order to derive sharper results about the behavior 639
of individual consumption. The other substantial model introduced in this chapter is the search for ideas model in subsection 16.5.2, which is adapted from McCall’s (1978) labor market search model. McCall’s model is the basis of much of the modern equilibrium theory of unemployment. While the model here has been cast in terms of searching for ideas, the reader can easily adapt it to unemployment and use it as an introduction to equilibrium unemployment theory (see Exercise 16.12). In addition, some of the other applications, mentioned above and treated in exercises, including the asset pricing model based on Lucas (1978) and the model of investment under uncertainty, are widely used models in other areas of macroeconomics.
16.7.