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Time-Varying Returns, Intertemporal Substitution and Cyclical Variation in Consumption

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  • De Veirman Emmanuel

    ()
    (Reserve Bank of New Zealand)

  • Dunstan Ashley

    ()
    (Reserve Bank of New Zealand)

Abstract

This paper studies the importance of intertemporal substitution in consumption for the cyclical co-movement of consumption, net worth and income. We can largely explain the empirical hump-shaped consumption response to a transitory wealth increase by allowing for time-varying returns in an otherwise standard Permanent Income Hypothesis (PIH) model. At the net worth peak, households bring consumption forward in anticipation of low returns on saving. The PIH model fully explains the empirical response when households initially expect the net worth shock to be permanent, but gradually learn that it is in fact transitory.

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Article provided by De Gruyter in its journal The B.E. Journal of Macroeconomics.

Volume (Year): 11 (2011)
Issue (Month): 1 (July)
Pages: 1-41

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Handle: RePEc:bpj:bejmac:v:11:y:2011:i:1:n:23

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Cited by:
  1. Reserve Bank of New Zealand, 2011. "Submission to the Productivity Commission inquiry on housing affordability," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 74, pages 30-38, September.
  2. Ozer Karagedikli & Michael Ryan & Daan Steenkamp & Tugrul Vehbi, 2013. "What happens when the Kiwi flies? The sectoral effects of the exchange rate shocks," CAMA Working Papers 2013-73, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  3. Özer Karagedikli & Ryan, Michael & Daan Steenkamp & Tugrul Vehbi, 2013. "What happens when the Kiwi flies? Sectoral effects of the exchange rate shocks," Reserve Bank of New Zealand Discussion Paper Series DP2013/05, Reserve Bank of New Zealand.

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