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Death to the Log-Linearized Consumption Euler Equation! (And Very Poor Health to the Second-Order Approximation)

  • Christopher D. Carroll

This paper shows that standard empirical methods for estimating log-linearized consumption Euler equations cannot successfully uncover structural parameters like the coefficient of relative risk aversion from the dataset of simulated consumers behaving exactly according to the standard model. Furthermore, consumption growth for the simulated consumers is very highly statistically related to predictable income growth - and thus standard 'excess sensitivity' tests would reject the hypothesis that consumers are behaving according to the standard model. Results are not much better for the second-order approximation to the Euler equation. The paper concludes that empirical estimation of consumption Euler equations should not be abandoned, and discusses some alternative empirical strategies that are not subject to the problems of Euler equation estimation.

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File URL: http://www.nber.org/papers/w6298.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6298.

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Date of creation: Dec 1997
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Publication status: published as Advances in Macroeconomics, (B.E. Journal of Macroeconomics), November 2001, Vol. 1, no. 1, Article 6
Handle: RePEc:nbr:nberwo:6298
Note: EFG ME
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  1. Gourinchas, Pierre-Olivier & Parker, Jonathan A, 2000. "Consumption Over the Life-Cycle," CEPR Discussion Papers 2345, C.E.P.R. Discussion Papers.
  2. Christopher D. Carroll & Andrew A. Samwick, 1995. "The Nature of Precautionary Wealth," NBER Working Papers 5193, National Bureau of Economic Research, Inc.
  3. 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.
  4. Orazio Attanasio & Hamish Low, 2002. "Estimating Euler equations," IFS Working Papers W02/06, Institute for Fiscal Studies.
  5. Chris Carroll & Lawrence H. Summers, 1989. "Consumption Growth Parallels Income Growth: Some New Evidence," NBER Working Papers 3090, National Bureau of Economic Research, Inc.
  6. Christopher D. Carroll, 1992. "The Buffer-Stock Theory of Saving: Some Macroeconomic Evidence," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 23(2), pages 61-156.
  7. Robert B. Barsky & Miles S. Kimball & F. Thomas Juster & Matthew D. Shapiro, 1995. "Preference Parameters and Behavioral Heterogeneity: An Experimental Approach in the Health and Retirement Survey," NBER Working Papers 5213, National Bureau of Economic Research, Inc.
  8. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July.
  9. Christopher D. Carroll & Miles S. Kimball, 1995. "On the Concavity of the Consumption Function," Macroeconomics 9503003, EconWPA.
  10. Zeldes, Stephen P, 1989. "Optimal Consumption with Stochastic Income: Deviations from Certainty Equivalence," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 275-98, May.
  11. Michaelides, Alexander & Ng, Serena, 2000. "Estimating the rational expectations model of speculative storage: A Monte Carlo comparison of three simulation estimators," Journal of Econometrics, Elsevier, vol. 96(2), pages 231-266, June.
  12. repec:fth:harver:1435 is not listed on IDEAS
  13. Lawrance, Emily C, 1991. "Poverty and the Rate of Time Preference: Evidence from Panel Data," Journal of Political Economy, University of Chicago Press, vol. 99(1), pages 54-77, February.
  14. Martin Browning & Annamaria Lusardi, 1996. "Household Saving: Micro Theories and Micro Facts," Discussion Papers 96-01, University of Copenhagen. Department of Economics.
  15. Dynan, Karen E, 1993. "How Prudent Are Consumers?," Journal of Political Economy, University of Chicago Press, vol. 101(6), pages 1104-13, December.
  16. Karen E. Dynan, 1993. "How prudent are consumers?," Working Paper Series / Economic Activity Section 135, Board of Governors of the Federal Reserve System (U.S.).
  17. Attanasio, Orazio P & Weber, Guglielmo, 1995. "Is Consumption Growth Consistent with Intertemporal Optimization? Evidence from the Consumer Expenditure Survey," Journal of Political Economy, University of Chicago Press, vol. 103(6), pages 1121-57, December.
  18. Shapiro, Matthew D., 1984. "The permanent income hypothesis and the real interest rate : Some evidence from panel data," Economics Letters, Elsevier, vol. 14(1), pages 93-100.
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