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

  • Carroll Christopher Dixon


    (Johns Hopkins University)

This paper shows that standard methods for estimating log-linearized consumption Euler equations using micro data cannot successfully uncover structural parameters like the coefficient of relative risk aversion from a 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 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 be abandoned, and discusses some alternative empirical strategies that are not subject to the problems of Euler equation estimation.

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Article provided by De Gruyter in its journal The B.E. Journal of Macroeconomics.

Volume (Year): 1 (2001)
Issue (Month): 1 (April)
Pages: 1-38

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Handle: RePEc:bpj:bejmac:v:advances.1:y:2001:i:1:n:6
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  1. Orazio Attanasio & Hamish Low, 2002. "Estimating Euler equations," IFS Working Papers W02/06, Institute for Fiscal Studies.
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  10. John Y. Campbell & N. Gregory Mankiw, 1989. "Consumption, Income and Interest Rates: Reinterpreting the Time Series Evidence," NBER Chapters, in: NBER Macroeconomics Annual 1989, Volume 4, pages 185-246 National Bureau of Economic Research, Inc.
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  14. 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.
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  18. Chris Carroll & Lawrence H. Summers, 1989. "Consumption Growth Parallels Income Growth: Some New Evidence," NBER Working Papers 3090, National Bureau of Economic Research, Inc.
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