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Death to the Log-Linearized Consumption Euler Equation! (And Very Poor Health to the Second-Order Approximation)

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  • Carroll Christopher Dixon

    ()
    (Johns Hopkins University)

Abstract

This paper shows that standard methods for estimating log-linearized consumption Euler equations using micro data cannot successfully uncover structural parameters like the coefficient of relative risk aversion from a dataset of simulated consumers behaving exactly according to the standard model. Furthermore, consumption growth for the simulated consumers is very highly statistically related to predictable income growth -- and thus standard `excess sensitivity' tests would reject the hypothesis that consumers are behaving according to the model. Results are not much better for the second-order approximation to the Euler equation. The paper concludes that empirical estimation of consumption Euler equations should be abandoned, and discusses some alternative empirical strategies that are not subject to the problems of Euler equation estimation.

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Bibliographic Info

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

Volume (Year): 1 (2001)
Issue (Month): 1 (April)
Pages: 1-38

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Handle: RePEc:bpj:bejmac:v:advances.1:y:2001:i:1:n:6

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  1. Orazio P. Attanasio & Hamish Low, 2004. "Estimating Euler Equations," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(2), pages 405-435, April.
  2. Christopher D. Carroll & Andrew A. Samwick, 1995. "The Nature of Precautionary Wealth," NBER Working Papers 5193, National Bureau of Economic Research, Inc.
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  7. Zeldes, Stephen P, 1989. "Optimal Consumption with Stochastic Income: Deviations from Certainty Equivalence," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 275-98, May.
  8. Attanasio, Orazio P & Weber, Guglielmo, 1995. "Is Consumption Growth Consistent with Intertemporal Optimization? Evidence from the Consumer Expenditure Survey," Journal of Political Economy, University of Chicago Press, vol. 103(6), pages 1121-57, December.
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  11. Christopher D. Carroll, 1992. "The Buffer-Stock Theory of Saving: Some Macroeconomic Evidence," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 23(2), pages 61-156.
  12. Shapiro, Matthew D., 1984. "The permanent income hypothesis and the real interest rate : Some evidence from panel data," Economics Letters, Elsevier, vol. 14(1), pages 93-100.
  13. Carroll, Christopher D & Kimball, Miles S, 1996. "On the Concavity of the Consumption Function," Econometrica, Econometric Society, vol. 64(4), pages 981-92, July.
  14. Lawrance, Emily C, 1991. "Poverty and the Rate of Time Preference: Evidence from Panel Data," Journal of Political Economy, University of Chicago Press, vol. 99(1), pages 54-77, February.
  15. Martin Browning & Annamaria Lusardi, 1995. "Household Saving: Micro Theories and Micro Facts," Department of Economics Working Papers 1995-02, McMaster University.
  16. Dynan, Karen E, 1993. "How Prudent Are Consumers?," Journal of Political Economy, University of Chicago Press, vol. 101(6), pages 1104-13, December.
  17. repec:fth:harver:1435 is not listed on IDEAS
  18. Karen E. Dynan, 1993. "How prudent are consumers?," Working Paper Series / Economic Activity Section 135, Board of Governors of the Federal Reserve System (U.S.).
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