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Elasticity of Intertemporal Substitution in Consumption in the Presence of Inertia: Empirical Evidence from a Natural Experiment

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  • Mudit Kapoor

    (Economics and Planning Unit, Indian Statistical Institute, New Delhi 110016, India)

  • Shamika Ravi

    (Economics and Governance Studies, Brookings Institution India Center, New Delhi 110024, India)

Abstract

This paper estimates the elasticity of intertemporal substitution in consumption (σ) by exploiting a natural experiment provided by a change in the Indian banking legislation. The new legislation authorized banks to offer higher interest rates on deposits to citizens above 60 years of age. We find evidence that households exhibit inertia in reoptimization and are sensitive to the timing of the actual change in the interest rate. Households do not respond to the predictable changes in future interest rates induced by the change in the legislation. We incorporate this and estimate the σ to be approximately equal to 2.2. This paper was accepted by Amit Seru, finance .

Suggested Citation

  • Mudit Kapoor & Shamika Ravi, 2017. "Elasticity of Intertemporal Substitution in Consumption in the Presence of Inertia: Empirical Evidence from a Natural Experiment," Management Science, INFORMS, vol. 63(12), pages 4188-4200, December.
  • Handle: RePEc:inm:ormnsc:v:63:y:2017:i:12:p:4188-4200
    DOI: 10.1287/mnsc.2016.2564
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    References listed on IDEAS

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