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Consumption: Beyond Certainty Equivalence

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  • Olivier J. Blanchard
  • N. Gregory Mankiw

Abstract

This paper discusses the recent research on the consumption function that has attempted to relax the assumption of certainty equivalence. While there remain many open questions, both theoretical and empirical, it is clear that the assumption of certainty equivalence can be misleading. Under more plausible specifications of preferences toward risk, uncertainty lowers the level of consumption, increases the expected rate of growth of consumption, and increases the response of consumption to news about income. Moreover, changes in the amount of uncertainty are a potentially important source of fluctuations in consumption.

Suggested Citation

  • Olivier J. Blanchard & N. Gregory Mankiw, 1988. "Consumption: Beyond Certainty Equivalence," NBER Working Papers 2496, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:2496 Note: EFG
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    1. Kimball, Miles S & Mankiw, N Gregory, 1989. "Precautionary Saving and the Timing of Taxes," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 863-879, August.
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    5. Hayne E. Leland, 1968. "Saving and Uncertainty: The Precautionary Demand for Saving," The Quarterly Journal of Economics, Oxford University Press, vol. 82(3), pages 465-473.
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    Cited by:

    1. Jan-Oliver Menz & Lena Vogel, 2009. "A Detailed Derivation of the Sticky Price and Sticky Information New Keynesian DSGE Model," Macroeconomics and Finance Series 200902, Hamburg University, Department Wirtschaft und Politik.
    2. Garcia-Penalosa, Cecilia & Turnovsky, Stephen J., 2005. "Production risk and the functional distribution of income in a developing economy: tradeoffs and policy responses," Journal of Development Economics, Elsevier, vol. 76(1), pages 175-208, February.
    3. Damien Echevin, 1999. "Nouvelles approches des comportements d'épargne et de consommation," Économie et Statistique, Programme National Persée, vol. 324(1), pages 9-18.
    4. Jetter, Michael & Nikolsko-Rzhevskyy, Alex & Smith, William T., 2013. "The effects of wage volatility on growth," Journal of Macroeconomics, Elsevier, vol. 37(C), pages 93-109.
    5. Hideaki Tamura & Yoichi Matsuabayashi, 2016. "Alternative Resolution to the Mehra?Prescott Puzzle: Verification by the Original Data," Discussion Papers 1634, Graduate School of Economics, Kobe University.
    6. Gomes, Fábio Augusto Reis & Ribeiro, Priscila Fernandes, 2015. "Estimating the elasticity of intertemporal substitution taking into account the precautionary savings motive," Journal of Macroeconomics, Elsevier, vol. 45(C), pages 108-123.
    7. Atreya Chakraborty & Mark Kazarosian, 1999. "Portfolio Allocation of Precautionary Assets: Panel Evidence for the United States," Boston College Working Papers in Economics 432, Boston College Department of Economics.
    8. William Smith, 1998. "Birth, Death, and Consumption: Overlapping Generations and the Random Walk Hypothesis," International Economic Journal, Taylor & Francis Journals, vol. 12(4), pages 105-116.
    9. Rodepeter, Ralf, 1997. "Identifikation von Sparprofilen im Lebenszyklus," Papers 97-01, Sonderforschungsbreich 504.
    10. Letendre, Marc-Andre & Smith, Gregor W., 2001. "Precautionary saving and portfolio allocation: DP by GMM," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 197-215, August.
    11. Saving and Investment Task Force & Rodriguez-Palenzuela, Diego & Dées, Stéphane & Andersson, Malin & Bijsterbosch, Martin & Forster, Katrin & Zorell, Nico & Audoly, Richard & Buelens, Christian & Comp, 2016. "Savings and investment behaviour in the euro area," Occasional Paper Series 167, European Central Bank.
    12. Atreya Chakraborty & Mark Kazarosian & Emery Trahan, 1999. "Uncertainty in Executive Compensation and Capital Investment: A Panel Study," Boston College Working Papers in Economics 434, Boston College Department of Economics.
    13. Jan-Oliver Menz, 2010. "Uncertainty, social norms and consumption theory: Post and New Keynesian approaches," European Journal of Economics and Economic Policies: Intervention, Edward Elgar Publishing, vol. 7(1), pages 125-146.
    14. repec:kob:wpaper:1634 is not listed on IDEAS
    15. Paul Hiebert & Javier J. Pérez & Massimo Rostagno, 2002. "Debt reduction and automatic stabilisation," Economic Working Papers at Centro de Estudios Andaluces E2002/12, Centro de Estudios Andaluces.
    16. Meghir, Costas & Pistaferri, Luigi, 2011. "Earnings, Consumption and Life Cycle Choices," Handbook of Labor Economics, Elsevier.
    17. Zhou, Yanfei, 2003. "Precautionary saving and earnings uncertainty in Japan: A household-level analysis," Journal of the Japanese and International Economies, Elsevier, vol. 17(2), pages 192-212, June.
    18. Schwarze, Johannes, 2008. "Subjective Measures of Economic Well-Being and the Influence of Income Uncertainty," IZA Discussion Papers 3720, Institute for the Study of Labor (IZA).
    19. Johannes Schwarze, 1994. "Subjective Measures of Economic Well-Being and the Influence of Income Uncertainty," Discussion Papers of DIW Berlin 94, DIW Berlin, German Institute for Economic Research.
    20. Talmain, Gabriel, 1998. "An analytical approximate solution to the problem of precautionary savings," Journal of Economic Dynamics and Control, Elsevier, vol. 23(1), pages 113-124, September.
    21. Daniel, Betty C., 1997. "Precautionary saving and persistent current account imbalance," Journal of International Economics, Elsevier, vol. 42(1-2), pages 179-193, February.
    22. Smith, William T., 2002. "Consumption and saving with habit formation and durability," Economics Letters, Elsevier, vol. 75(3), pages 369-375, May.
    23. Sidorenko, Alexandra, 2001. "Stochastic Model of Demand for Medical Care with Endogenous Labour Supply and Health Insurance," Departmental Working Papers 2001-08, The Australian National University, Arndt-Corden Department of Economics.
    24. Fischer Black, 1989. "Mean Reversion and Consumption Smoothing," NBER Working Papers 2946, National Bureau of Economic Research, Inc.
    25. Päivi Kankaanranta, 2006. "Consumption Over the Life Cycle: A Selected Literature Review," Discussion Papers 7, Aboa Centre for Economics.

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