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Elasticities of substitution in real business cycle models with home production

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  • John Y. Campbell
  • Sydney Ludvigson

Abstract

Recently, there has been considerable interest in modifying the standard real business cycle model to include home production. In this paper, we construct a simple model of home production that demonstrates the connection between the intertemporal elasticity of substitution (IES), and the elasticity of substitution between home and market consumption. Understanding this connection is important because there is much larger body of empirical evidence on the size of the IES than there is on the size of the static home-market substitution elasticity. We use this framework to shed light on the properties of a home production model with empirically plausible (lower) values of the IES. In particular, we find that such a model must display two fundamental properties in order to reproduce certain key aspects of the U.S. aggregate data: first, the steady state growth rate of technology must be the same across sectors. Second, out of steady state, shocks to technology must be sufficiently positively correlated across sectors.

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Bibliographic Info

Paper provided by Federal Reserve Bank of New York in its series Research Paper with number 9733.

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Date of creation: 1997
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Handle: RePEc:fip:fednrp:9733

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Keywords: Business cycles ; Econometric models ; Production (Economic theory);

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References

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  1. Urban J. Jermann & Marianne Baxter, 1999. "Household Production and the Excess Sensitivity of Consumption to Current Income," American Economic Review, American Economic Association, vol. 89(4), pages 902-920, September.
  2. Attanasio, Orazio P & Weber, Guglielmo, 1993. "Consumption Growth, the Interest Rate and Aggregation," Review of Economic Studies, Wiley Blackwell, vol. 60(3), pages 631-49, July.
  3. Eisner, Robert, 1988. "Extended Accounts for National Income and Product," Journal of Economic Literature, American Economic Association, vol. 26(4), pages 1611-84, December.
  4. John Y. Campbell & N. Gregory Mankiw, 1991. "Permanent Income, Current Income, and Consumption," NBER Working Papers 2436, National Bureau of Economic Research, Inc.
  5. Hansen, Gary D., 1985. "Indivisible labor and the business cycle," Journal of Monetary Economics, Elsevier, vol. 16(3), pages 309-327, November.
  6. Greenwood, Jeremy & Hercowitz, Zvi, 1991. "The Allocation of Capital and Time over the Business Cycle," Journal of Political Economy, University of Chicago Press, vol. 99(6), pages 1188-214, December.
  7. Hall, Robert E, 1988. "Intertemporal Substitution in Consumption," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 339-57, April.
  8. Benhabib, Jess & Rogerson, Richard & Wright, Randall, 1991. "Homework in Macroeconomics: Household Production and Aggregate Fluctuations," Journal of Political Economy, University of Chicago Press, vol. 99(6), pages 1166-87, December.
  9. Greenwood, J. & Rogerson, R. & Wright, R., 1993. "Household Production in Real Business Cycle Thoery," RCER Working Papers 347, University of Rochester - Center for Economic Research (RCER).
  10. Martin S. Eichenbaum & Lars Peter Hansen & Kenneth J. Singleton, 1986. "A Time Series Analysis of Representative Agent Models of Consumption andLeisure Choice Under Uncertainty," NBER Working Papers 1981, National Bureau of Economic Research, Inc.
  11. John Y. Campbell & N. Gregory Mankiw, 1990. "Consumption, Income, and Interest Rates: Reinterpreting the Time Series Evidence," NBER Working Papers 2924, National Bureau of Economic Research, Inc.
  12. Beaudry, Paul & van Wincoop, Eric, 1996. "The Intertemporal Elasticity of Substitution: An Exploration Using a US Panel of State Data," Economica, London School of Economics and Political Science, vol. 63(251), pages 495-512, August.
  13. John Y. Campbell, 1992. "Inspecting the Mechanism: An Analytical Approach to the Stochastic Growth Model," NBER Working Papers 4188, National Bureau of Economic Research, Inc.
  14. Baxter, M. & Crucini, M.J., 1990. "Explaining Saving/Investment Correlation," RCER Working Papers 224, University of Rochester - Center for Economic Research (RCER).
  15. John Y. Campbell, 1998. "Asset Prices, Consumption, and the Business Cycle," NBER Working Papers 6485, National Bureau of Economic Research, Inc.
  16. repec:fth:harver:1435 is not listed on IDEAS
  17. Juster, F Thomas & Stafford, Frank P, 1991. "The Allocation of Time: Empirical Findings, Behavioral Models, and Problems of Measurement," Journal of Economic Literature, American Economic Association, vol. 29(2), pages 471-522, June.
  18. Peter Rupert & Richard Rogerson & Randall Wright, 1994. "Estimating substitution elasticities in household production models," Staff Report 186, Federal Reserve Bank of Minneapolis.
  19. Ellen McGrattan & Richard Rogerson & Randall Wright, 1993. "Household production and taxation in the stochastic growth model," Staff Report 166, Federal Reserve Bank of Minneapolis.
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