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Sequential optimization, front-loaded information, and U.S. consumption

  • Willman, Alpo

In an overlapping generations maximization framework with consumers, whose information on uncertain future income realizations is front loaded, a closed form aggregate consumption function with CRRA preferences is derived. To have a closed form solution we assume that consumers solve their intertemporal optimization problem sequentially. First they assess riskadjusted life-time wealth and then the optimal consumption path. The derived model captures precautionary saving, which is dependent on the human to non-human wealth ratio. On aggregate level, after accounting for habit formation, the model is able to explain both the short-run (e.g. the excess sensitivity and the excess smoothness puzzle) and long-run stylized facts of the U.S. consumption data. JEL Classification: D11, D12, D82, E21

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Paper provided by European Central Bank in its series Working Paper Series with number 0765.

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Date of creation: Jun 2007
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Handle: RePEc:ecb:ecbwps:20070765
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