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Sentiment Predictable Income and Habits in the Dynamics of Aggregate Consumption

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  • Martin Sommer

Abstract

This paper explores whether habit formation in the representative agent’s preferences can explain two failures of the standard permanent income model with intertemporally separable utility: the sensitivity of consumption to lagged consumer sentiment and to predictable changes in current income I show that in a habit formation model the sensitivity of consumption growth to predicted income can be to a large extent reinterpreted as a sluggish response of consumption to news Moreover the sensitivity of consumption growth to lagged sentiment merely reflects the serial corre-lation in consumption growth generated by habits I study the model’s predictions for the effect of the recent tax cut on aggregate consumption Contrary to the PIH model consumers with habits respond to permanent tax cuts slowly The estimated model predicts an immediate (first-quarter) MPC out of the permanent tax cut of only 30%

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Paper provided by The Johns Hopkins University,Department of Economics in its series Economics Working Paper Archive with number 458.

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Date of creation: Nov 2001
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Handle: RePEc:jhu:papers:458
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  1. Andrew B. Abel, . "Asset Prices Under Habit Formation and Catching Up With the Jones," Rodney L. White Center for Financial Research Working Papers 1-90, Wharton School Rodney L. White Center for Financial Research.
  2. Pischke, Jorn-Steffen, 1995. "Individual Income, Incomplete Information, and Aggregate Consumption," Econometrica, Econometric Society, vol. 63(4), pages 805-40, July.
  3. Christopher D. Carroll & Jody Overland & David N. Weil, 1995. "Saving and growth with habit formation," Finance and Economics Discussion Series 95-42, Board of Governors of the Federal Reserve System (U.S.).
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  5. Christopher D Carroll, 2000. "'Risky Habits' and the Marginal Propensity to Consume Out of Permanent Income or How Much Would a Permanent Tax Cut Boost Japanese Consumption?," Economics Working Paper Archive 429, The Johns Hopkins University,Department of Economics.
  6. Christopher D. Carroll, 1997. "Buffer-Stock Saving and the Life Cycle/Permanent Income Hypothesis," The Quarterly Journal of Economics, Oxford University Press, vol. 112(1), pages 1-55.
  7. Marianne Baxter & Urban J. Jermann, 1999. "Household Production and the Excess Sensitivity of Consumption to Current Income," NBER Working Papers 7046, National Bureau of Economic Research, Inc.
  8. Muellbauer, John, 1986. "Habits, Rationality and Myopia in the Life-Cycle Consumption Function," CEPR Discussion Papers 112, C.E.P.R. Discussion Papers.
  9. repec:adr:anecst:y:1988:i:9 is not listed on IDEAS
  10. Sydney C. Ludvigson & Alexander Michaelides, 2001. "Does Buffer-Stock Saving Explain the Smoothness and Excess Sensitivity of Consumption?," American Economic Review, American Economic Association, vol. 91(3), pages 631-647, June.
  11. Matthew D. Shapiro & Joel Slemrod, 2001. "Consumer Response to Tax Rebates," NBER Working Papers 8672, National Bureau of Economic Research, Inc.
  12. Wayne E. Ferson & George M. Constantinides, 1991. "Habit Persistence and Durability in Aggregate Consumption: Empirical Tests," NBER Working Papers 3631, National Bureau of Economic Research, Inc.
  13. John Y. Campbell & N. Gregory Mankiw, 1989. "Consumption, Income, and Interest Rates: Reinterpreting the Time Series Evidence," NBER Working Papers 2924, National Bureau of Economic Research, Inc.
  14. Constantinides, George M, 1990. "Habit Formation: A Resolution of the Equity Premium Puzzle," Journal of Political Economy, University of Chicago Press, vol. 98(3), pages 519-43, June.
  15. Jermann, Urban J., 1998. "Asset pricing in production economies," Journal of Monetary Economics, Elsevier, vol. 41(2), pages 257-275, April.
  16. Carroll, Christopher D & Fuhrer, Jeffrey C & Wilcox, David W, 1994. "Does Consumer Sentiment Forecast Household Spending? If So, Why?," American Economic Review, American Economic Association, vol. 84(5), pages 1397-1408, December.
  17. Martin Sommer & Christopher Carroll, 2004. "Epidemiological expectations and consumption dynamics," Money Macro and Finance (MMF) Research Group Conference 2003 92, Money Macro and Finance Research Group.
  18. repec:fth:harver:1435 is not listed on IDEAS
  19. repec:adr:anecst:y:1988:i:9:p:03 is not listed on IDEAS
  20. Hall, Robert E, 1978. "Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 971-87, December.
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