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Consumption: Beyond Certainty Equivalence

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  • Blanchard, Olivier Jean
  • Mankiw, N Gregory

Abstract

This paper discusses the recent research on the consumption function that has attempted to relax the assumption of certainty equivalence. While there remain many open questions, both theoretical and empirical, it is clear that the assumption of certainty equivalence can be misleading. Under more plausible specifications of preferences toward risk, uncertainty lowers the level of consumption, increases the expected rate of growth of consumption, and increases the response of consumption to news about income. Moreover, changes in the amount of uncertainty are a potentially important source of fluctuations in consumption.

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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 78 (1988)
Issue (Month): 2 (May)
Pages: 173-77

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Handle: RePEc:aea:aecrev:v:78:y:1988:i:2:p:173-77

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References

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  1. Kotlikoff, Laurence J & Summers, Lawrence H, 1981. "The Role of Intergenerational Transfers in Aggregate Capital Accumulation," Journal of Political Economy, University of Chicago Press, vol. 89(4), pages 706-32, August.
  2. Kimball, Miles S. & Mankiw, N. Gregory, 1989. "Precautionary Saving and the Timing of Taxes," Scholarly Articles 3443105, Harvard University Department of Economics.
  3. Bertola, Giuseppe, 1998. "Irreversible investment," Research in Economics, Elsevier, vol. 52(1), pages 3-37, March.
  4. Dreze, Jacques H. & Modigliani, Franco, 1972. "Consumption decisions under uncertainty," Journal of Economic Theory, Elsevier, vol. 5(3), pages 308-335, December.
  5. Robert E. Hall & Frederic S. Mishkin, 1980. "The Sensitivity of Consumption to Transitory Income: Estimates from Panel Data on Households," NBER Working Papers 0505, National Bureau of Economic Research, Inc.
  6. Sandmo, Agnar, 1970. "The Effect of Uncertainty on Saving Decisions," Review of Economic Studies, Wiley Blackwell, vol. 37(3), pages 353-60, July.
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Citations

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Cited by:
  1. Schwarze, Johannes, 2008. "Subjective Measures of Economic Well-Being and the Influence of Income Uncertainty," IZA Discussion Papers 3720, Institute for the Study of Labor (IZA).
  2. Marc-Andre Letendre & Gregor Smith, 2000. "Precautionary saving and portfolio allocation: DP by GMM," Working Papers 1247, Queen's University, Department of Economics.
  3. Talmain, Gabriel, 1998. "An analytical approximate solution to the problem of precautionary savings," Journal of Economic Dynamics and Control, Elsevier, vol. 23(1), pages 113-124, September.
  4. Smith, William T., 2002. "Consumption and saving with habit formation and durability," Economics Letters, Elsevier, vol. 75(3), pages 369-375, May.
  5. Atreya Chakraborty & Mark Kazarosian & Emery Trahan, 1999. "Uncertainty in Executive Compensation and Capital Investment: A Panel Study," Boston College Working Papers in Economics 434, Boston College Department of Economics.
  6. Atreya Chakraborty & Mark Kazarosian, 1999. "Portfolio Allocation of Precautionary Assets: Panel Evidence for the United States," Boston College Working Papers in Economics 432, Boston College Department of Economics.
  7. Fischer Black, 1989. "Mean Reversion and Consumption Smoothing," NBER Working Papers 2946, National Bureau of Economic Research, Inc.
  8. Jetter, Michael & Nikolsko-Rzhevskyy, Alex & Smith, William T., 2013. "The effects of wage volatility on growth," Journal of Macroeconomics, Elsevier, vol. 37(C), pages 93-109.
  9. William Smith, 1998. "Birth, Death, and Consumption: Overlapping Generations and the Random Walk Hypothesis," International Economic Journal, Taylor & Francis Journals, vol. 12(4), pages 105-116.
  10. Sidorenko, Alexandra, 2001. "Stochastic Model of Demand for Medical Care with Endogenous Labour Supply and Health Insurance," Departmental Working Papers 2001-08, The Australian National University, Arndt-Corden Department of Economics.
  11. Cecilia Garcia-Penalosa & Stephen Turnovsky, 2003. "Production Risk and the Functional Distribution of Income in a Developing Economy: Tradeoffs and Policy Responses," Working Papers UWEC-2002-07-P, University of Washington, Department of Economics, revised Oct 2003.
  12. Zhou, Yanfei, 2003. "Precautionary saving and earnings uncertainty in Japan: A household-level analysis," Journal of the Japanese and International Economies, Elsevier, vol. 17(2), pages 192-212, June.
  13. Jan-Oliver Menz & Lena Vogel, 2009. "A Detailed Derivation of the Sticky Price and Sticky Information New Keynesian DSGE Model," Macroeconomics and Finance Series 200902, Hamburg University, Department Wirtschaft und Politik.
  14. Hiebert, Paul & Pérez, Javier J. & Rostagno, Massimo, 2002. "Debt reduction and automatic stabilisation," Working Paper Series 0189, European Central Bank.
  15. Päivi Kankaanranta, 2006. "Consumption Over the Life Cycle: A Selected Literature Review," Discussion Papers 7, Aboa Centre for Economics.
  16. Daniel, Betty C., 1997. "Precautionary saving and persistent current account imbalance," Journal of International Economics, Elsevier, vol. 42(1-2), pages 179-193, February.

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