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Risky Habits and the Marginal Propensity to Consume Output of Permanent Income, or, How Much Would a Permanent Tax Cut Boost Japanese Consumption?

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  • D. Carroll Christopher

Abstract

Papers in a variety of disparate literatures have recently suggested that habit formation in consumption may explain several empirical puzzles, ranging from the level and cyclical variability of the equity premium (Abel, 1990, 1999: Constantinides, 1990; Jerman, 1998; Campbell and Cochrane, 1999) to the 'excess smoothness' of aggregate consumption (Fuhrer, 2000) to the apparent fact that increases in economic growth cause subsequent increase in aggregate saving rates (Carroll and Weil, 1994: Bosworth, 1993; Attanasio, Picci, and Scorceu, 2000; Rodrik, 1999; Layza, Schmidt-Hebbel, and Serven, 2000) This paper examines an implication of these models that has mostly been overlooked: Habits strong enough to solve these puzzles imply an immediate marginal propensity to consume out of permanent shocks of much lees than one. When the model is calibrated to roughly match the rise in the Japanese saving rate over the postwar periode, it implies that the immediate MPC out of Permanent tax cuts may be as low as 30 percent, suggesting that calls for a permanent income tax cut as a quick means of stimulating aggregate demand in Japan may be misguided. [D11, D81, D91, E10, E17, E21, H31]

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  • D. Carroll Christopher, 2000. "Risky Habits and the Marginal Propensity to Consume Output of Permanent Income, or, How Much Would a Permanent Tax Cut Boost Japanese Consumption?," International Economic Journal, Taylor & Francis Journals, vol. 14(4), pages 1-40.
    • Handle: RePEc:taf:intecj:v:14:y:2000:i:4:p:1-40
    DOI: 10.1080/10168730000000033
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    1. Abel, Andrew B, 1990. "Asset Prices under Habit Formation and Catching Up with the Joneses," American Economic Review, American Economic Association, vol. 80(2), pages 38-42, May.
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    1. Jean‐Noël Barrot & Erik Loualiche & Matthew Plosser & Julien Sauvagnat, 2022. "Import Competition and Household Debt," Journal of Finance, American Finance Association, vol. 77(6), pages 3037-3091, December.
    2. Fulgence Dominick Waryoba & Li Jing, 2019. "Consumption Uncertainty Reduction Among Sweet Potato Smallholder Farmers in Tanzania," Global Journal of Emerging Market Economies, Emerging Markets Forum, vol. 11(1-2), pages 132-147, January.
    3. Martin Sommer, 2004. "Habits, Sentiment and Predictable Income in the Dynamics of Aggregate Consumption," Macroeconomics 0408004, University Library of Munich, Germany.
    4. Kenneth N. Kuttner & Adam S. Posen, 2001. "The Great Recession: Lessons for Macroeconomic Policy from Japan," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 32(2), pages 93-186.
    5. Martin Sommer & Christopher Carroll, 2004. "Epidemiological expectations and consumption dynamics," Money Macro and Finance (MMF) Research Group Conference 2003 92, Money Macro and Finance Research Group.
    6. HORI Masahiro & SHIMIZUTANI Satoshi, 2002. "Micro Data Studies on Japanese Tax Policy and Consumption in the 1990s," ESRI Discussion paper series 014, Economic and Social Research Institute (ESRI).
    7. Martin Sommer, 2001. "Sentiment Predictable Income and Habits in the Dynamics of Aggregate Consumption," Economics Working Paper Archive 458, The Johns Hopkins University,Department of Economics.

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