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Habit Persistence, Nonseparability between Consumption and Leisure, or Rule-of-Thumb Consumers: Which Accounts for the Predictability of Consumption Growth?

  • Michael T. Kiley

    (Federal Reserve Board)

Consumption growth is predictable, a basic violation of the permanent-income hypothesis. This paper examines three possible explanations: rule-of-thumb behavior, in which households allow consumption to track per period income flows rather than permanent income; habit persistence; and nonseparability in preferences over consumption and leisure. The results illustrate that weak instruments make the results highly sensitive to some arbitrary choices common in the literature. Using a technique that is robust to instrument choice, the analysis shows support for habit persistence and rule-of-thumb behavior and little support for nonseparability between consumption and leisure.

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Article provided by MIT Press in its journal The Review of Economics and Statistics.

Volume (Year): 92 (2010)
Issue (Month): 3 (August)
Pages: 679-683

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Handle: RePEc:tpr:restat:v:92:y:2010:i:3:p:679-683
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  1. Christopher D Carroll, 1997. "Death to the Log-Linearized Consumption euler Equation! (And Very Poor Health to the Second-Order Approximation)," Economics Working Paper Archive 390, The Johns Hopkins University,Department of Economics.
  2. 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.
  3. Campbell, John Y. & Mankiw, N. Gregory, 1990. "Permanent Income, Current Income, and Consumption," Scholarly Articles 3353762, Harvard University Department of Economics.
  4. Morten Ravn & Stephanie Schmitt-Grohé & Mart�n Uribe, 2006. "Deep Habits," Review of Economic Studies, Oxford University Press, vol. 73(1), pages 195-218.
  5. G. Constantinides, 1990. "Habit formation: a resolution of the equity premium puzzle," Levine's Working Paper Archive 1397, David K. Levine.
  6. Thomas Tallarini & Harold Zhang, . "External Habit and the Cyclicality of Expected Stock Returns," GSIA Working Papers 1997-26, Carnegie Mellon University, Tepper School of Business.
  7. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Working Paper 0107, Federal Reserve Bank of Cleveland.
  8. John Y. Campbell & John H. Cochrane, 1995. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," NBER Working Papers 4995, National Bureau of Economic Research, Inc.
  9. Reis, Ricardo, 2006. "Inattentive consumers," Journal of Monetary Economics, Elsevier, vol. 53(8), pages 1761-1800, November.
  10. Campbell, John & Deaton, Angus, 1989. "Why Is Consumption So Smooth?," Scholarly Articles 3221494, Harvard University Department of Economics.
  11. Cochrane, John H, 1994. "Permanent and Transitory Components of GNP and Stock Prices," The Quarterly Journal of Economics, MIT Press, vol. 109(1), pages 241-65, February.
  12. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 107(2), pages 205-251, April.
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