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Time-Varying Returns, Intertemporal Substitution and Cyclical Variation in Consumption

  • Emmanuel De Veirman

    ()

  • Ashley Dunstan

    ()

This paper studies the importance of intertemporal substitution in consumption for the cyclical co-movement of consumption, net worth and income. We can largely explain the empirical hump-shaped consumption response to a transitory wealth increase by allowing for time-varying returns in an otherwise standard Permanent Income Hypothesis (PIH) model. At the net worth peak, households bring consumption forward in anticipation of low returns on saving. The PIH model fully explains the empirical response when households initially expect the net worth shock to be permanent, but gradually learn that it is in fact transitory.

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File URL: https://cama.crawford.anu.edu.au/pdf/working-papers/2011/142011.pdf
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Paper provided by Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University in its series CAMA Working Papers with number 2011-14.

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Length: 51 pages
Date of creation: Jun 2011
Date of revision:
Handle: RePEc:een:camaaa:2011-14
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