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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%

Suggested Citation

  • Martin Sommer, 2001. "Sentiment Predictable Income and Habits in the Dynamics of Aggregate Consumption," Economics Working Paper Archive 458, The Johns Hopkins University,Department of Economics.
    • Handle: RePEc:jhu:papers:458
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    File URL: http://www.econ2.jhu.edu/REPEC/papers/wp458Sommer_06.pdf
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    References listed on IDEAS

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    Cited by:

    1. van de Ven, Justin, 2011. "A structural dynamic microsimulation model of household savings and labour supply," Economic Modelling, Elsevier, vol. 28(4), pages 2054-2070, July.
    2. Malgarini, Marco & Margani, Patrizia, 2005. "Psychology, consumer sentiment and household expenditures: a disaggregated analysis," MPRA Paper 42443, University Library of Munich, Germany.

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