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Credit Constraints, Learning and Aggregate Consumption Volatility

  • Daniel Tortorice

    ()

    (Department of Economics, Brandeis University)

This paper documents three empirical facts. First, the volatility of consumption growth relative to income growth rose from 1947-1960 and then fell dramatically by 50 percent from the 1960s to the 1990s. Second, the correlation between consumption growth and personal income growth fell by about 50 percent over the same time period. Finally, the absolute deviation of consumption growth from its mean exhibits one break in U.S. data, and the mean of the absolute deviations has fallen by about 30 percent. First, I find that a standard dynamic, stochastic general equilibrium model is unable to explain these facts. Then, I examine the ability of two hypotheses: a fall in credit constraints and changing beliefs about the permanence of income shocks to account for these facts. I find evidence for both explanations and the beliefs explanation is more consistent with the data. Importantly, I find that estimated changes in beliefs about the permanence of income shocks have significant explanatory power for consumption changes.

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File URL: http://www.brandeis.edu/departments/economics/RePEc/brd/doc/Brandeis_WP06.pdf
File Function: Second version, 2009
Download Restriction: no

File URL: http://www.brandeis.edu/departments/economics/RePEc/brd/doc/Brandeis_WP06R.pdf
File Function: Third version, 2011
Download Restriction: no

Paper provided by Brandeis University, Department of Economics and International Businesss School in its series Working Papers with number 06.

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Length: 34 pages
Date of creation: Nov 2007
Date of revision: Nov 2009
Handle: RePEc:brd:wpaper:06
Contact details of provider: Postal: MS032, P.O. Box 9110, Waltham, MA 02454-9110
Web page: http://www.brandeis.edu/departments/economics/

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  1. Mark Aguiar & Gita Gopinath, 2007. "Emerging Market Business Cycles: The Cycle Is the Trend," Journal of Political Economy, University of Chicago Press, vol. 115, pages 69-102.
  2. Margaret M. McConnell & Gabriel Perez Quiros, 1997. "Output fluctuations in the United States: what has changed since the early 1980s?," Research Paper 9735, Federal Reserve Bank of New York.
  3. Jushan Bai & Pierre Perron, 2003. "Computation and analysis of multiple structural change models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 18(1), pages 1-22.
  4. Fatih Guvenen, 2006. "Learning your earning: are labor income shocks really very persistent?," Discussion Paper / Institute for Empirical Macroeconomics 145, Federal Reserve Bank of Minneapolis.
  5. Jushan Bai & Pierre Perron, 1998. "Estimating and Testing Linear Models with Multiple Structural Changes," Econometrica, Econometric Society, vol. 66(1), pages 47-78, January.
  6. Dynan, Karen E. & Elmendorf, Douglas W. & Sichel, Daniel E., 2006. "Can financial innovation help to explain the reduced volatility of economic activity?," Journal of Monetary Economics, Elsevier, vol. 53(1), pages 123-150, January.
  7. Stephen G. Cecchetti & Alfonso Flores-Lagunes & Stefan Krause, 2006. "Assessing the Sources of Changes in the Volatility of Real Growth," NBER Working Papers 11946, National Bureau of Economic Research, Inc.
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