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Elasticities of substitution in real business cycle models with home production

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  • John Y. Campbell
  • Sydney Ludvigson

Abstract

Recently, there has been considerable interest in modifying the standard real business cycle model to include home production. In this paper, we construct a simple model of home production that demonstrates the connection between the intertemporal elasticity of substitution (IES), and the elasticity of substitution between home and market consumption. Understanding this connection is important because there is much larger body of empirical evidence on the size of the IES than there is on the size of the static home-market substitution elasticity. We use this framework to shed light on the properties of a home production model with empirically plausible (lower) values of the IES. In particular, we find that such a model must display two fundamental properties in order to reproduce certain key aspects of the U.S. aggregate data: first, the steady state growth rate of technology must be the same across sectors. Second, out of steady state, shocks to technology must be sufficiently positively correlated across sectors.

Suggested Citation

  • John Y. Campbell & Sydney Ludvigson, 1997. "Elasticities of substitution in real business cycle models with home production," Research Paper 9733, Federal Reserve Bank of New York.
  • Handle: RePEc:fip:fednrp:9733
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    References listed on IDEAS

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    1. Greenwood, Jeremy & Hercowitz, Zvi, 1991. "The Allocation of Capital and Time over the Business Cycle," Journal of Political Economy, University of Chicago Press, vol. 99(6), pages 1188-1214, December.
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    3. Benhabib, Jess & Rogerson, Richard & Wright, Randall, 1991. "Homework in Macroeconomics: Household Production and Aggregate Fluctuations," Journal of Political Economy, University of Chicago Press, vol. 99(6), pages 1166-1187, December.
    4. Baxter, Marianne & Crucini, Mario J, 1993. "Explaining Saving-Investment Correlations," American Economic Review, American Economic Association, vol. 83(3), pages 416-436, June.
    5. Campbell, John Y., 1999. "Asset prices, consumption, and the business cycle," Handbook of Macroeconomics,in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 19, pages 1231-1303 Elsevier.
    6. Rupert, Peter & Rogerson, Richard & Wright, Randall, 1995. "Estimating Substitution Elasticities in Household Production Models," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 6(1), pages 179-193, June.
    7. Urban J. Jermann & Marianne Baxter, 1999. "Household Production and the Excess Sensitivity of Consumption to Current Income," American Economic Review, American Economic Association, vol. 89(4), pages 902-920, September.
    8. Campbell, John Y., 1994. "Inspecting the mechanism: An analytical approach to the stochastic growth model," Journal of Monetary Economics, Elsevier, vol. 33(3), pages 463-506, June.
    9. Greenwood, J. & Rogerson, R. & Wright, R., 1993. "Household Production in Real Business Cycle Thoery," RCER Working Papers 347, University of Rochester - Center for Economic Research (RCER).
    10. Orazio P. Attanasio & Guglielmo Weber, 1993. "Consumption Growth, the Interest Rate and Aggregation," Review of Economic Studies, Oxford University Press, vol. 60(3), pages 631-649.
    11. Juster, F Thomas & Stafford, Frank P, 1991. "The Allocation of Time: Empirical Findings, Behavioral Models, and Problems of Measurement," Journal of Economic Literature, American Economic Association, vol. 29(2), pages 471-522, June.
    12. Martin S. Eichenbaum & Lars Peter Hansen & Kenneth J. Singleton, 1988. "A Time Series Analysis of Representative Agent Models of Consumption and Leisure Choice Under Uncertainty," The Quarterly Journal of Economics, Oxford University Press, vol. 103(1), pages 51-78.
    13. John Y. Campbell & N. Gregory Mankiw, 1989. "Consumption, Income and Interest Rates: Reinterpreting the Time Series Evidence," NBER Chapters,in: NBER Macroeconomics Annual 1989, Volume 4, pages 185-246 National Bureau of Economic Research, Inc.
    14. Beaudry, Paul & van Wincoop, Eric, 1996. "The Intertemporal Elasticity of Substitution: An Exploration Using a US Panel of State Data," Economica, London School of Economics and Political Science, vol. 63(251), pages 495-512, August.
    15. Hall, Robert E, 1988. "Intertemporal Substitution in Consumption," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 339-357, April.
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    19. repec:fth:harver:1435 is not listed on IDEAS
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