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Time-varying returns, intertemporal substitution and cyclical variation in consumption

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This paper studies the importance of intertemporal substitution in consumption for the cyclical co-movement of consumption, net worth and income in New Zealand. We can largely explain the empirical hump-shaped consumption response to a transitory wealth increase by allowing for time-varying returns in an otherwise standard Permanent Income Hypothesis (PIH) model. At the net worth peak, households bring consumption forward in anticipation of low returns on saving. The PIH model fully explains the empirical response when households initially expect the net worth shock to be permanent, but gradually learn that it is in fact transitory.

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Paper provided by Reserve Bank of New Zealand in its series Reserve Bank of New Zealand Discussion Paper Series with number DP2011/05.

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Length: 47 p.
Date of creation: Aug 2011
Handle: RePEc:nzb:nzbdps:2011/05
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