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Alternative Specifications for Consumption and the Estimation of the Intertemporal Elasticity of Substitution

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  • Beaudry, P.
  • Van Wincoop, E.

Abstract

This paper documents several advantages associated with using state level consumption data to examine consumption behavior and especially to estimate the Intertemporal Elasticity of Substitution (IES). In contrast to the results of Hall (1988) and Campbell and Mankiw (1989), we provide substantial evidence indicating that the IES is significantly different from zero and probably close to one. Since the overidentifying restrictions of the standard Euler equation are generally rejected, we use these data to explore the nature of these rejections and evaluate an alternative specification of consumer behavior proposed by Campbell and Mankiw (1987, 1989, 1990). We take special care of examining the robustness of our results with respect to problems caused by the mismeasurement of the interest rate. In particular, we identify a common time component in expected consumption growth across states which, under the specifications of the theory, should reflect real interest rate movements. We find that the common time component closely matches the expected real return on Treasury bills as should be expected if the IES is different from zero and if the T-bill rate is an appropriate measure of interest rates.

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Bibliographic Info

Paper provided by Boston University - Department of Economics in its series Papers with number 2.

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Length: 22 pages
Date of creation: 1992
Date of revision:
Handle: RePEc:fth:bostec:2

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Keywords: consumption ; economic models ; elasticity;

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References

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  1. Nelson, Charles R & Startz, Richard, 1990. "The Distribution of the Instrumental Variables Estimator and Its t-Ratio When the Instrument Is a Poor One," The Journal of Business, University of Chicago Press, vol. 63(1), pages S125-40, January.
  2. Hall, Robert E, 1988. "Intertemporal Substitution in Consumption," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 339-57, April.
  3. John Y. Campbell & N. Gregory Mankiw, 1991. "Permanent Income, Current Income, and Consumption," NBER Working Papers 2436, National Bureau of Economic Research, Inc.
  4. Mankiw, N Gregory & Rotemberg, Julio J & Summers, Lawrence H, 1985. "Intertemporal Substitution in Macroeconomics," The Quarterly Journal of Economics, MIT Press, vol. 100(1), pages 225-51, February.
  5. Mankiw, N. Gregory, 1981. "The permanent income hypothesis and the real interest rate," Economics Letters, Elsevier, vol. 7(4), pages 307-311.
  6. Robert E. Hall & Frederic S. Mishkin, 1982. "The Sensitivity of Consumption to Transitory Income: Estimates from Panel Data on Households," NBER Working Papers 0505, National Bureau of Economic Research, Inc.
  7. Hansen, Lars Peter & Singleton, Kenneth J, 1983. "Stochastic Consumption, Risk Aversion, and the Temporal Behavior of Asset Returns," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 249-65, April.
  8. Jappelli, Tullio, 1990. "Who Is Credit Constrained in the U.S. Economy?," The Quarterly Journal of Economics, MIT Press, vol. 105(1), pages 219-34, February.
  9. Hansen, Lars Peter & Singleton, Kenneth J, 1982. "Generalized Instrumental Variables Estimation of Nonlinear Rational Expectations Models," Econometrica, Econometric Society, vol. 50(5), pages 1269-86, September.
  10. Summers, Lawrence H, 1981. "Capital Taxation and Accumulation in a Life Cycle Growth Model," American Economic Review, American Economic Association, vol. 71(4), pages 533-44, September.
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Cited by:
  1. David Altig & Charles T. Carlstrom, 1994. "The efficiency and welfare effects of tax reform: are fewer tax brackets better than more?," Economic Review, Federal Reserve Bank of Cleveland, issue Q IV, pages 30-42.
  2. Paolo Pesenti & Eric van Wincoop, 1996. "Do Nontraded Goods Explain the Home Bias Puzzle?," NBER Working Papers 5784, National Bureau of Economic Research, Inc.
  3. David Altig & Charles T. Carlstrom, 1995. "Marginal tax rates and income inequality: a quantitative-theoretic analysis," Working Paper 9508, Federal Reserve Bank of Cleveland.
  4. van Wincoop, Eric, 1995. "A note on short-term intersectoral factor immobility," Journal of Economic Dynamics and Control, Elsevier, vol. 19(4), pages 845-856, May.

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