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Elasticities of Substitution in Real Business Cycle Models with Home Protection

  • Campbell, John Y
  • Ludvigson, Sydney

This paper constructs a simple model of home production that demonstrates the connection between the intertemporal elasticity of substitution in market consumption (IES) and the static elasticity of substitution between home and market consumption (SES). Understanding this connection is important because there is a large body of empirical evidence suggesting that the IES is small, but little evidence on the size of the SES. We use our framework to shed light on the properties of a home production model with a low IES. We find that such a model must have three fundamental properties in order to match key aspects of aggregate U.S. data. First, the steady-state growth rate of technology must be the same across sectors. Second, shocks to technology must be sufficiently positively correlated across sectors. Third, capital must be used more intensively in the market sector than in the home sector. A home production model with these three properties can be surprisingly successful at reconciling the RBC paradigm with evidence for a low IES.

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Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 33 (2001)
Issue (Month): 4 (November)
Pages: 847-75

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Handle: RePEc:mcb:jmoncb:v:33:y:2001:i:4:p:847-75
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  1. Campbell, John Y & Mankiw, N Gregory, 1990. "Permanent Income, Current Income, and Consumption," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(3), pages 265-79, July.
  2. Campbell, John Y., 1994. "Inspecting the mechanism: An analytical approach to the stochastic growth model," Journal of Monetary Economics, Elsevier, vol. 33(3), pages 463-506, June.
  3. Campbell, John Y., 1999. "Asset prices, consumption, and the business cycle," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 19, pages 1231-1303 Elsevier.
  4. Gary Hansen, 2010. "Indivisible Labor and the Business Cycle," Levine's Working Paper Archive 233, David K. Levine.
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  6. Juster, F Thomas & Stafford, Frank P, 1991. "The Allocation of Time: Empirical Findings, Behavioral Models, and Problems of Measurement," Journal of Economic Literature, American Economic Association, vol. 29(2), pages 471-522, June.
  7. Baxter, M. & Crucini, M.J., 1990. "Explaining Saving/Investment Correlation," RCER Working Papers 224, University of Rochester - Center for Economic Research (RCER).
  8. Martin S. Eichenbaum & Lars Peter Hansen & Kenneth J. Singleton, 1986. "A Time Series Analysis of Representative Agent Models of Consumption andLeisure Choice Under Uncertainty," NBER Working Papers 1981, National Bureau of Economic Research, Inc.
  9. Robert E. Hall, 1981. "Intertemporal Substitution in Consumption," NBER Working Papers 0720, National Bureau of Economic Research, Inc.
  10. Rupert, Peter & Rogerson, Richard & Wright, Randall, 1995. "Estimating Substitution Elasticities in Household Production Models," Economic Theory, Springer, vol. 6(1), pages 179-93, June.
  11. Ellen R. McGrattan & Richard Rogerson & Randall Wright, 1993. "Household production and taxation in the stochastic growth model," Staff Report 166, Federal Reserve Bank of Minneapolis.
  12. John Y. Campbell & N. Gregory Mankiw, 1989. "Consumption, Income, and Interest Rates: Reinterpreting the Time Series Evidence," NBER Working Papers 2924, National Bureau of Economic Research, Inc.
  13. Benhabib, Jess & Rogerson, Richard & Wright, Randall, 1991. "Homework in Macroeconomics: Household Production and Aggregate Fluctuations," Journal of Political Economy, University of Chicago Press, vol. 99(6), pages 1166-87, December.
  14. Marianne Baxter & Urban J. Jermann, 1999. "Household Production and the Excess Sensitivity of Consumption to Current Income," NBER Working Papers 7046, National Bureau of Economic Research, Inc.
  15. Greenwood, J. & Hercowitz, Z., 1991. "The Allocation of Capital and Time Over the Business Cycle," RCER Working Papers 268, University of Rochester - Center for Economic Research (RCER).
  16. Attanasio, Orazio P & Weber, Guglielmo, 1993. "Consumption Growth, the Interest Rate and Aggregation," Review of Economic Studies, Wiley Blackwell, vol. 60(3), pages 631-49, July.
  17. Greenwood, J. & Rogerson, R. & Wright, R., 1993. "Household Production in Real Business Cycle Thoery," RCER Working Papers 347, University of Rochester - Center for Economic Research (RCER).
  18. Eisner, Robert, 1988. "Extended Accounts for National Income and Product," Journal of Economic Literature, American Economic Association, vol. 26(4), pages 1611-84, December.
  19. 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.
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