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Euler Equations, Subjective Expectations and Income Shocks

Author

Listed:
  • Attanasio, Orazio

    (UCL)

  • Kovacs, Agnes

    (University of Oxford)

  • Molnar, Krisztina

    (Dept. of Economics, Norwegian School of Economics and Business Administration)

Abstract

In this paper, we make three substantive contributions: first, we use elicited subjective income expectations to identify the levels of permanent and transitory income shocks in a life-cycle framework; second, we use these shocks to assess whether households' consumption is insulated from them; third, we use the shock data to estimate an Euler equation for consumption. We find that households are able to smooth transitory shocks, but adjust their consumption in response to permanent shocks, albeit not fully. The estimates of the Euler equation parameters with and without expectational errors are similar, which is consistent with rational expectations. We break new ground by combining data on subjective expectations about future income from the Michigan Survey with micro data on actual Income from the Consumer Expenditure Survey.

Suggested Citation

  • Attanasio, Orazio & Kovacs, Agnes & Molnar, Krisztina, 2017. "Euler Equations, Subjective Expectations and Income Shocks," Discussion Paper Series in Economics 5/2017, Norwegian School of Economics, Department of Economics.
  • Handle: RePEc:hhs:nhheco:2017_005
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    File URL: https://brage.bibsys.no/xmlui/handle/11250/2437055
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    References listed on IDEAS

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    7. Milton Friedman, 1957. "A Theory of the Consumption Function," NBER Books, National Bureau of Economic Research, Inc, number frie57-1, june.
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    1. Euler Equations, Subjective Expectations and Income Shocks
      by maximorossi in NEP-LTV blog on 2017-06-01 18:49:51

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    Cited by:

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    2. Agnes Kovacs & Concetta Rondinelli & Serena Trucchi, 2018. "Permanent versus Transitory Income Shocks over the Business Cycle," Working Papers 2018:23, Department of Economics, University of Venice "Ca' Foscari".

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    More about this item

    Keywords

    life cycle models; estimating Euler Equations; survey expectations;
    All these keywords.

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • D12 - Microeconomics - - Household Behavior - - - Consumer Economics: Empirical Analysis
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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