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Sequential optimization, front-loaded information, and U.S. consumption

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Author Info
Alpo Willman () (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
Abstract

In an overlapping generations maximization framework with consumers, whose information on uncertain future income realizations is front-loaded, a closed form aggregate consumption function with CRRA preferences is derived. To have a closed form solution we assume that consumers solve their intertemporal optimization problem sequentially. First they assess riskadjusted life-time wealth and then the optimal consumption path. The derived model captures precautionary saving, which is dependent on the human to non-human wealth ratio. On aggregate level, after accounting for habit formation, the model is able to explain both the short-run (e.g. the excess sensitivity and the excess smoothness puzzle) and long-run stylized facts of the U.S. consumption data. JEL Classification: D11, D12, D82, E21.

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Paper provided by European Central Bank in its series Working Paper Series with number 765.

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Length: 36 pages
Date of creation: Jun 2007
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Handle: RePEc:ecb:ecbwps:20070765

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Keywords: Consumption Information Habit Persistence Precautionary Saving.

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