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Humps and Bumps in Lifetime Consumption

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  • Orazio P. Attanasio
  • James Banks
  • Costas Meghir
  • Guglielmo Weber

Abstract

In this paper we argue that once one departs from the simple classroom example, or `stripped down life-cycle model,' the empirical model for consumption growth can be made flexible enough to fit the main features of the data. More specifically, we show that allowing demographics to affect household preferences and relaxing the assumption of certainty equivalence can generate hump-shaped consumption profiles over age that are very similar to those observed in household-level data sources, without appealing to alternative explanations (such as liquidity constraints, myopia or mental accounting). The hump-shape is partly attributable to precautionary savings, and partly due to demographics; the tracking (whereby consumption jumps with income) is instead due to the permanent nature of the income shocks. We use US household-level data to estimate preference parameters and income profiles, and then simulate consumption profiles for different education groups. Our simulated profiles show that the key features observed in the data can be closely matched in simulation. We also show that neglecting uncertainty produces consumption profiles that are `too flat,' whereas neglecting demographics generates consumption profiles that peak `too late.'

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5350.

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Date of creation: Nov 1995
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Publication status: published as Journal of Business and Economic Statistics, Vol. 17, no. 1 (January 1999): 22-35.
Handle: RePEc:nbr:nberwo:5350

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  1. Altonji, Joseph G & Siow, Aloysius, 1987. "Testing the Response of Consumption to Income Changes with (Noisy) Panel Data," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 102(2), pages 293-328, May.
  2. Judd, Kenneth L., 1992. "Projection methods for solving aggregate growth models," Journal of Economic Theory, Elsevier, Elsevier, vol. 58(2), pages 410-452, December.
  3. Sumru Altug & Robert Miller, . "Household Choices in Equilibrium," University of Chicago - Population Research Center, Chicago - Population Research Center 87-8, Chicago - Population Research Center.
  4. Marcet, Albert & Singleton, Kenneth J., 1999. "Equilibrium Asset Prices And Savings Of Heterogeneous Agents In The Presence Of Incomplete Markets And Portfolio Constraints," Macroeconomic Dynamics, Cambridge University Press, Cambridge University Press, vol. 3(02), pages 243-277, June.
  5. MaCurdy, Thomas E., 1982. "The use of time series processes to model the error structure of earnings in a longitudinal data analysis," Journal of Econometrics, Elsevier, Elsevier, vol. 18(1), pages 83-114, January.
  6. John M. Abowd & David Card, 1986. "On the Covariance Structure of Earnings and Hours Changes," NBER Working Papers 1832, National Bureau of Economic Research, Inc.
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