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The time-series properties of aggregate consumption: implications for the costs of fluctuations

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Ricardo Reis (Princeton University, NBER, and CEPR)

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Abstract

While this is typically ignored, the properties of the stochastic process followed by aggregate consumption affect the estimates of the costs of fluctuations. This paper pursues two approaches to modelling aggregate consumption dynamics and to measuring how much society dislikes fluctuations, one statistical and one economic. The statistical approach estimates the properties of consumption and calculates the cost of having consumption fluctuating around its mean growth. The paper finds that the persistence of consumption is a crucial determinant of these costs and that the high persistence in the data severely distorts conventional measures. It shows how to compute valid estimates and confidence intervals. The economic approach uses a calibrated model of optimal consumption and measures the costs of eliminating income shocks. This uncovers a further cost of uncertainty, through its impact on precautionary savings and investment. The two approaches lead to costs of fluctuations that are higher than the common wisdom, between 0.5% and 5% of per capita consumption.

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Paper provided by Princeton University, Woodrow Wilson School of Public and International Affairs, Discussion Papers in Economics. in its series Working Papers with number 134.

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Date of creation: Apr 2005
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Handle: RePEc:pri:wwseco:134

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Keywords: Costs of fluctuations Models of aggregate consumption Consumption persistence

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Find related papers by JEL classification:
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
E21 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General

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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Mauricio A. Hernández & Munir A. Jalil & Carlos Esteban Posada, . "El Costo de los Ciclos Económicos en Colombia: Una Nueva Estimación," Borradores de Economia 353, Banco de la Republica de Colombia. [Downloadable!]
    Other versions:
  2. Pengfei Wang & Yi Wen, 2007. "Endogenous volatility, endogenous growth, and large welfare gains from stabilization policies," Working Papers 2006-032, Federal Reserve Bank of St. Louis. [Downloadable!]
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