'Risky Habits' and the Marginal Propensity to Consume Out of Permanent Income or How Much Would a Permanent Tax Cut Boost Japanese Consumption?
AbstractPapers in a variety of disparate literatures have recently suggested that habit formation in consumption may explain several empirical puzzles ranging from the level and cyclical variability of the equity premium (Abel (19901999); Constantinides (1990); Jermann (1998); Campbell and Cochrane (1999)) to the 'excess smoothness' of aggregate consumption (Fuhrer (2000)) to the apparent fact that increases in economic growth cause subsequent increases in aggregate saving rates (Carroll and Weil (1994); Bosworth (1993); Attanasio Picci and Scorcu (2000); Rodrik (1999); Loayza Schmidt-Hebbel and Serven (2000)) This paper examines an implication of these models that has mostly been overlooked: Habits strong enough to solve these puzzles imply an immediate marginal propensity to consume out of permanent shocks of much less than one When the model is calibrated to roughly match the rise in the Japanese saving rate over the postwar period it implies that the immediate MPC out of permanent tax cuts may be as low as 30 percent suggesting that calls for a permanent income tax cut as a quick means of stimulating aggregate demand in Japan may be misguided
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Bibliographic InfoPaper provided by The Johns Hopkins University,Department of Economics in its series Economics Working Paper Archive with number 429.
Date of creation: Jul 2000
Date of revision:
Other versions of this item:
- Christopher D. Carroll, 2000. "'Risky Habits' and the Marginal Propensity to Consume Out of Permanent Income, or, How Much Would a Permanent Tax Cut Boost Japanese Consumption?," NBER Working Papers 7839, National Bureau of Economic Research, Inc.
- D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
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