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Precautionary saving demand and consumption dynamics with the spirit of capitalism and regime switching

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  • Wang, Haijun

Abstract

This paper explores how the spirit of capitalism and regime switching affect the precautionary saving demand and consumption dynamics for two settings in which labor income growth depends on observable and unobservable economic regimes, which are defined as continuous-time Markov chains. I show that the spirit of capitalism reduces the precautionary saving demand, while regime switching increases the precautionary saving demand. With the spirit of capitalism and regime switching, the excess sensitivity puzzle can be resolved to some extent. Unlike Luo et al. (2009), I show that the spirit of capitalism can interpret the excess smoothness puzzle when labor income follows a unit root process or an Ornstein–Uhlenbeck process which is widely used in the literature of consumption and saving. I find that regime switching would worsen the excess smoothness puzzle under complete information, while the excess smoothness puzzle can be resolved by regime switching under incomplete information. Finally, I discuss the effects of the spirit of capitalism and regime switching on the welfare gain of information.

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  • Wang, Haijun, 2016. "Precautionary saving demand and consumption dynamics with the spirit of capitalism and regime switching," Journal of Mathematical Economics, Elsevier, vol. 64(C), pages 48-65.
    • Handle: RePEc:eee:mateco:v:64:y:2016:i:c:p:48-65
    DOI: 10.1016/j.jmateco.2016.03.006
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