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The Intertemporal Elasticity of Substitution: An Exploration Using a US Panel of State Data

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  • Beaudry, Paul
  • van Wincoop, Eric

Abstract

This paper uses state-level consumption data to estimate the intertemporal elasticity of substitution of consumption (IES). In contrast to the results of Hall (1988) and Campbell and Mankiw (1989), we provide evidence indicating that the IES is significantly different from zero and probably close to one. Since inference about the IES in the context of the standard Euler equation is problematic as a result of mis-specification bias, we cast most of our discussion in the context of the framework developed by Campbell and Mankiw. This modifies the Euler equation in that a fraction of agents simply consume their income. The use of panel data to examine the relationship between interest rates and consumption growth has two advantages. First, we achieve a significant increase in precision, which in particular allows us to rule out a zero IES. Second, we can use the panel aspect of the data to bypass asset return measurement problems. In particular, we identify a common time component in expected consumption growth that is associated with movements in interest rates when the IES is positive. Copyright 1996 by The London School of Economics and Political Science.

Suggested Citation

  • Beaudry, Paul & van Wincoop, Eric, 1996. "The Intertemporal Elasticity of Substitution: An Exploration Using a US Panel of State Data," Economica, London School of Economics and Political Science, vol. 63(251), pages 495-512, August.
  • Handle: RePEc:bla:econom:v:63:y:1996:i:251:p:495-512
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