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Habits, Sentiment and Predictable Income in the Dynamics of Aggregate Consumption

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  • Martin Sommer

    (International Monetary Fund)

Abstract

This paper explores whether habit formation in the representative agent’s preferences can explain two failures of the standard permanent income model: the sensitivity to lagged consumer sentiment, and to predictable changes in income. I show that in a habit formation model, the sensitivity of consumption to predicted income can be largely reinterpreted as a sluggish response to news. Moreover, the sensitivity of consumption to sentiment reflects the serial correlation in consumption growth generated by habits. The estimated model predicts an immediate (first-quarter) MPC out of a permanent tax cut of only about 30%.

Suggested Citation

  • Martin Sommer, 2004. "Habits, Sentiment and Predictable Income in the Dynamics of Aggregate Consumption," Macroeconomics 0408004, University Library of Munich, Germany.
  • Handle: RePEc:wpa:wuwpma:0408004
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    References listed on IDEAS

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    11. Jermann, Urban J., 1998. "Asset pricing in production economies," Journal of Monetary Economics, Elsevier, vol. 41(2), pages 257-275, April.
    12. 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.
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    Cited by:

    1. Christopher D. Carroll & Misuzu Otsuka & Jirka Slacalek, 2006. "How Large Is the Housing Wealth Effect? A New Approach," NBER Working Papers 12746, National Bureau of Economic Research, Inc.
    2. Jiri Slacalek, 2006. "International Wealth Effects," Computing in Economics and Finance 2006 425, Society for Computational Economics.
    3. Dudek, Sławomir, 2008. "Consumer Survey Data and short-term forecasting of households consumption expenditures in Poland," MPRA Paper 19818, University Library of Munich, Germany.
    4. 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.
    5. 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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    More about this item

    Keywords

    Consumer sentiment; excess sensitivity; habit formation; consumption; marginal propensity to consume; tax cuts;
    All these keywords.

    JEL classification:

    • E10 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - General
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H31 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Household

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