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'Risky Habits' and the Marginal Propensity to Consume Out of Permanent Income, or, How Much Would a Permanent Tax Cut Boost Japanese Consumption?

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  • Christopher D. Carroll

Abstract

Papers in 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 (1990,1999); 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 Serv‚n (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 permanent income tax cut as a quick means of stimulating aggregate demand in Japan may be misguided.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7839.

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Date of creation: Aug 2000
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Publication status: published as Carroll, Christopher D. "Risks Habits' And The Marginal Propensity To Consume Out Of Permanent Income, Or, How Much Would A Permanent Tax Cut Boost Japanese Consumption?," International Economic Journal, 2000, v14(4,Winter), 1-40.
Handle: RePEc:nbr:nberwo:7839

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Cited by:
  1. Francisco Alvarez-Cuadrado, 2006. "Growth Outside The Stable Path: Lessons From The European Reconstruction," Departmental Working Papers 2006-02, McGill University, Department of Economics.
  2. Martin Sommer & Christopher Carroll, 2004. "Epidemiological expectations and consumption dynamics," Money Macro and Finance (MMF) Research Group Conference 2003 92, Money Macro and Finance Research Group.
  3. Martin Sommer, 2001. "Sentiment Predictable Income and Habits in the Dynamics of Aggregate Consumption," Economics Working Paper Archive 458, The Johns Hopkins University,Department of Economics.
  4. Martin Sommer, 2004. "Habits, Sentiment and Predictable Income in the Dynamics of Aggregate Consumption," Macroeconomics 0408004, EconWPA.
  5. Shimizutani, Satoshi, 2006. "Consumer response to the 1998 tax cut: Is a temporary tax cut effective?," Journal of the Japanese and International Economies, Elsevier, vol. 20(2), pages 269-287, June.

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