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Near-Rationality, Heterogeneity, and Aggregate Consumption

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  • Caballero, Ricardo J

Abstract

The simple permanent-income model provides a good description of the medium-long run behavior of aggregate non-durables consumption, but fails to describe its short run behavior. In this paper I, present a non-representative agent model with near-rational macroeconomic units a la Akerlof-Yellen that simultaneously explains the observed excess smoothness of consumption to wealth innovations and the excess sensitivity of consumption to lagged income changes. This models also explains conditional asymmetries found in the data: in good times, consumers respond more promptly to positive than negative wealth shocks; while the opposite is true in bad times. In spite of the presence of large non-diversifiable idiosyncratic uncertainty, the estimated dollar equivalent utility cost of the macroeconomic near-rational strategy required to explain the aggregate facts is only about 0.037 percent of consumption per year, where [gamma] is the coefficient of relative risk aversion. Copyright 1995 by Ohio State University Press.

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  • Caballero, Ricardo J, 1995. "Near-Rationality, Heterogeneity, and Aggregate Consumption," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(1), pages 29-48, February.
    • Handle: RePEc:mcb:jmoncb:v:27:y:1995:i:1:p:29-48
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    1. Hall, Robert E, 1978. "Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 971-987, December.
    2. Akerlof, George A & Yellen, Janet L, 1985. "Can Small Deviations from Rationality Make Significant Differences to Economic Equilibria?," American Economic Review, American Economic Association, vol. 75(4), pages 708-720, September.
    3. Caballero, Ricardo J, 1993. "Durable Goods: An Explanation for Their Slow Adjustment," Journal of Political Economy, University of Chicago Press, vol. 101(2), pages 351-384, April.
    4. Cochrane, John H, 1989. "The Sensitivity of Tests of the Intertemporal Allocation of Consumption to Near-Rational Alternatives," American Economic Review, American Economic Association, vol. 79(3), pages 319-337, June.
    5. Hall, Robert E & Mishkin, Frederic S, 1982. "The Sensitivity of Consumption to Transitory Income: Estimates from Panel Data on Households," Econometrica, Econometric Society, vol. 50(2), pages 461-481, March.
    6. Robert E. Hall, 1987. "Consumption," NBER Working Papers 2265, National Bureau of Economic Research, Inc.
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