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Death to the Log-Linearized Consumption Euler Equation! (And Very Poor Health to the Second-Order Approximation)

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  • Christopher D. Carroll

Abstract

This paper shows that standard empirical methods for estimating log-linearized consumption Euler equations cannot successfully uncover structural parameters like the coefficient of relative risk aversion from the dataset of simulated consumers behaving exactly according to the standard model. Furthermore, consumption growth for the simulated consumers is very highly statistically related to predictable income growth - and thus standard 'excess sensitivity' tests would reject the hypothesis that consumers are behaving according to the standard model. Results are not much better for the second-order approximation to the Euler equation. The paper concludes that empirical estimation of consumption Euler equations should not be abandoned, and discusses some alternative empirical strategies that are not subject to the problems of Euler equation estimation.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6298.

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Date of creation: Dec 1997
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Publication status: published as Advances in Macroeconomics, (B.E. Journal of Macroeconomics), November 2001, Vol. 1, no. 1, Article 6
Handle: RePEc:nbr:nberwo:6298

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  1. John Y. Campbell & N. Gregory Mankiw, 1989. "Consumption, Income, and Interest Rates: Reinterpreting the Time Series Evidence," NBER Working Papers 2924, National Bureau of Economic Research, Inc.
  2. Alexander Michaelides & Serena Ng, 1997. "Estimating the Rational Expectations Model of Speculative Storage: A Monte Carlo Comparison of Three Simulation Estimators," Boston College Working Papers in Economics 373, Boston College Department of Economics.
  3. repec:fth:harver:1435 is not listed on IDEAS
  4. Martin Browning & Annamaria Lusardi, 1996. "Household Saving: Micro Theories and Micro Facts," Journal of Economic Literature, American Economic Association, vol. 34(4), pages 1797-1855, December.
  5. Lawrance, Emily C, 1991. "Poverty and the Rate of Time Preference: Evidence from Panel Data," Journal of Political Economy, University of Chicago Press, vol. 99(1), pages 54-77, February.
  6. Orazio P. Attanasio & Guglielmo Weber, 1994. "Is Consumption Growth Consistent with Intertemporal Optimization? Evidence from the Consumer Expenditure Survey," NBER Working Papers 4795, National Bureau of Economic Research, Inc.
  7. Stephen Zeldes, . "Optimal Consumption with Stochastic Income: Deviations from Certainty Equivalence," Rodney L. White Center for Financial Research Working Papers 20-86, Wharton School Rodney L. White Center for Financial Research.
  8. Christopher D. Carroll & Miles S. Kimball, 1995. "On the concavity of the consumption function," Finance and Economics Discussion Series 95-10, Board of Governors of the Federal Reserve System (U.S.).
  9. Christopher D. Carroll & Lawrence H. Summers, 1991. "Consumption Growth Parallels Income Growth: Some New Evidence," NBER Chapters, in: National Saving and Economic Performance, pages 305-348 National Bureau of Economic Research, Inc.
  10. Dynan, Karen E, 1993. "How Prudent Are Consumers?," Journal of Political Economy, University of Chicago Press, vol. 101(6), pages 1104-13, December.
  11. Orazio P. Attanasio & Hamish Low, 2000. "Estimating Euler Equations," NBER Technical Working Papers 0253, National Bureau of Economic Research, Inc.
  12. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July.
  13. Pierre-Olivier Gourinchas & Jonathan A. Parker, 2002. "Consumption Over the Life Cycle," Econometrica, Econometric Society, vol. 70(1), pages 47-89, January.
  14. Karen E. Dynan, 1993. "How prudent are consumers?," Working Paper Series / Economic Activity Section 135, Board of Governors of the Federal Reserve System (U.S.).
  15. Shapiro, Matthew D., 1984. "The permanent income hypothesis and the real interest rate : Some evidence from panel data," Economics Letters, Elsevier, vol. 14(1), pages 93-100.
  16. Christopher D. Carroll, 1992. "The Buffer-Stock Theory of Saving: Some Macroeconomic Evidence," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 23(2), pages 61-156.
  17. Robert B. Barsky & Miles S. Kimball & F. Thomas Juster & Matthew D. Shapiro, 1995. "Preference Parameters and Behavioral Heterogeneity: An Experimental Approach in the Health and Retirement Survey," NBER Working Papers 5213, National Bureau of Economic Research, Inc.
  18. Carroll, Christopher D. & Samwick, Andrew A., 1997. "The nature of precautionary wealth," Journal of Monetary Economics, Elsevier, vol. 40(1), pages 41-71, September.
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