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Euler Equations, Subjective Expectations and Income Shocks

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  • Orazio Attanasio
  • Agnes Kovacs
  • Krisztina Molnar

Abstract

In this paper, we make three substantive contributions. First, we use elicited subjective income expectations to identify the levels of permanent and transitory income shocks in a lifecycle framework. Second, we use these shocks to assess whether households’ consumption is insulated from them. Third, we use the shock data to estimate an Euler equation for consumption. We find that households are able to smooth transitory shocks, but adjust their consumption in response to permanent shocks, albeit not fully. The estimates of the Euler equation parameters with and without expectational errors are similar, which is consistent with rational expectations. We break new ground by combining data on subjective expectations about future income from the Michigan Survey with microdata on actual income from the Consumer Expenditure Survey.

Suggested Citation

  • Orazio Attanasio & Agnes Kovacs & Krisztina Molnar, 2020. "Euler Equations, Subjective Expectations and Income Shocks," Economica, London School of Economics and Political Science, vol. 87(346), pages 406-441, April.
  • Handle: RePEc:bla:econom:v:87:y:2020:i:346:p:406-441
    DOI: 10.1111/ecca.12318
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    Cited by:

    1. Gizem Koşar & Cormac O'Dea, 2022. "Expectations Data in Structural Microeconomic Models," NBER Working Papers 30094, National Bureau of Economic Research, Inc.
    2. Kovacs, Agnes & Rondinelli, Concetta & Trucchi, Serena, 2021. "Permanent versus transitory income shocks over the business cycle," European Economic Review, Elsevier, vol. 139(C).
    3. Stephane Bonhomme & Angela Denis, 2023. "Estimating Individual Responses when Tomorrow Matters," Papers 2310.09105, arXiv.org, revised May 2024.
    4. Meeks, Roland & Monti, Francesca, 2023. "Heterogeneous beliefs and the Phillips curve," Journal of Monetary Economics, Elsevier, vol. 139(C), pages 41-54.

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