Essays on the elasticity of intertemporal substitution iowa research. Attanasio and weber 1995 find an elasticity of intertemporal substitution. Consequently, the constant eis assumption can be tested with demand data. Furthermore, in contrast to the standard case of exponential discounting with isoelastic utility, the elasticity of intertemporal substitution for hyperbolic consumers depends on the duration of the change in the intertemporal relative price. On the intertemporal elasticity of substitution under.
In recent papers macurdy 1981a,bl examines intertemporal substitution effects at the microeconometric level. If the real rate rises, current consumption may decrease due to increased return on savings. Estimating the intertemporal substitution elasticity introduction the elasticity of intertemporal substitution eis, a key parameter in macroeconomics and nance, measures the sensitivity of expected consumption growth to the real interest rate ie the expected real return on a nominally riskfree asset. We provide two ways to reconcile small values of the intertemporal elasticity of substitution ies that range between 0. Elasticity of intertemporal substitution springerlink.
Elasticity of intertemporal substitution is a measure of responsiveness of the growth rate of consumption to the real interest rate. An economic term describing how an individuals current decisions affect what options become available in the future. Estimates using tbill returns suggest that this elasticity is close to zero. Making the case for a low intertemporal elasticity of substitution r. That elasticity can be measured by the response of the. Making the case for a low intertemporal elasticity of. Temporal and intertemporal utility functions application center. Intertemporal substitution and hyperbolic discounting. It plays a key role in the theory of consumption and saving, in particular in the lifecycle version of that theory. The consumption tax, which is a value added tax vat, increased from three to five percent in april 1997. Definition of intertemporal substitution econmodel. In the uk, the mortgage interest rate features discrete jumps notches at thresholds for the loantovalue ltv ratio. This dissertation estimates the elasticity of intertemporal substitution eis of con.
Estimating the elasticity of intertemporal substitution using mortgage notches. Lecture notes on elasticity of substitution ted bergstrom, ucsb economics 210a october 26, 2015 todays featured guest is \the elasticity of substitution. The calibrated value of the eis is varied over a range of values used. Much of the literature that focuses on this parameter is based on the estimation of the firstorder conditions associated with intertemporal optimization the euler equation approach.
It might at first seem that micro data provide a much firmer basis for estimating intertemporal substitution effects than do aggregate data. Only in the case where the investment opportunity set is constant, is the optimal portfolio weight independent of the elasticity of intertemporal substitution, though even in this case the consumption decision depends on both risk aversion and elasticity of intertemporal substitution. The purpose of this paper is to present improved estimates of the intertemporal elasticity of substitution ies for japan assuming a constant relative risk aversion crra utility function. Elasticity of intertemporal substitution journal of money and. The intertemporal elasticity of substitution ies is a key economic parameter for the. We present estimates of the elasticity of intertemporal substitution eis for iranian.
Measuring the intertemporal elasticity of substitution for. This panel thus highlights the sensitivity of the speed of convergence to both the elasticity of substitution in production and. This paper estimates the elasticity of intertemporal substitution in consumption. Estimates using smf returns suggest that this elasticity is positive and small. D12, d15, d84, e21 abstract we estimate the elasticity of intertemporal substitution eisthe response of expected. The eis is arguably one of the most important parameters in economics as it plays a central role for a range of questions in macro, public. If intertemporal preferences are additive, the eis is constant, and within period preferences are not homothetic, then the intertemporal preference parameter is identified by the curvature of engel curves. This paper documents several advantages associated with using state level consumption data to examine consumption behavior and especially to estimate the intertemporal elasticity of substitution ies. A taxbased estimate of the elasticity of intertemporal substitution jonathan gruber. Intertemporal labor supply university of hong kong. Then, using conventional statistical techniques, data generated from model simulations are used to estimate the elasticity. Normalising ces production functions in the calibration of basic dynamic. Theoretically, by not consuming today, consumption. In all common models of inter temporal allocation, the assumption of a constant elasticity of intertemporal substitution eis imposes surprising limitations on withinperiod budget allocations.
The elasticity of intertemporal substitution is defined as the percent change in consumption growth per percent increase in the net interest rate. The elasticity of intertemporal substitution in consumption, a key input into macroeconomic models, has been estimated by hundreds of researchers. Measuring intertemporal substitution in consumption. Crossley and low is the elasticity of intertemporal substitution constant. For instance, with an intertemporal elasticity of substitution of 0. Most of our estimates suffer from the weak instrument problem.
Highlights we estimate the elasticity of intertemporal substitution for the us economy. Later empirical studies, however, reject the intertemporal substitution in consumption hypothesis, because consumption seems to be overly sensitive to present income. We considered the tbill, stocks, and a synthetic mutual fund returns. A model economy is specified in which the modeler himself selects the intertemporal elasticity of substitution. This panel thus highlights the sensitivity of the speed of convergence to both the elasticity of substitution in production and the intertemporal elasticity of substitution. Elasticity of intertemporal substitution in consumption in. A taxbased estimate of the elasticity of intertemporal.
Her devotion to the program is what enables all of us students to. The parameter is known as the elasticity of intertemporal substitution. Only in the case where the investment opportunity set is constant, is the optimal portfolio weight independent of the elasticity of intertemporal substitution, though even in this case the consumption decision depends on both risk. Their estimates vary greatly, and it is unclear what values should be used for calibration. This step requires a numerical solution of the second stage of twostage budgeting to construct the indirect felicity function and its partial derivatives. In the diagram, the wage path ii differs from path i in that there is a temporary wage increase at time t.
Hall stanford university and national bureau of economic research one of the important determinants of the response of saving and consumption to the real interest rate is the elasticity of intertemporal substitution. On the use of elasticity of intertemporal substitution. Pdf measuring the intertemporal elasticity of substitution for. Measuring intertemporal substitution metaanalysis in economics. Mathematically, this is a bivariate ces function so we know that the elasticity of substitution will be constant between the two arguments, whatever they are. This paper denes the concept of elasticity of intergenerational substitution egs, and extends a standard dynastic model in order to disentangle the egs from the eis, or elasticity of intertemporal substitution. Our findings have implications for the numerous calibration studies that rely on larger values of the. The shape of the contour lines will look as follows. Estimating the elasticity of intertemporal substitution. The new legislation authorized banks to offer higher interest rates on deposits to citizens above 60 years of age.
The workhorse tool for the estimation of the eis is the loglinearized. Estimating the elasticity of intertemporal substitution using. On the use of elasticity of intertemporal substitution aleksandar georgiev. Calibration is an effective tool for imposing discipline on the choice. University joint global coe program raising market qualityintegrated. This paper documents several advantages associated with using state level consumption data to examine consumption behavior and especially to estimate the intertemporal elasticity of.
Anton braun and tomoyuki nakajima working paper 20121 january 2012 abstract. But avoid asking for help, clarification, or responding to other answers. Estimating intertemporal and intratemporal substitutions. Economic fluctuations and growth, public economics. The elasticity of intertemporal substitution in consumption, a key input into. Intertemporal substitution is the decision to forego current consumption in order to consume in the future. Alternative specifications for consumption and the estimation. Elasticity of intertemporal substitution or intertemporal elasticity of substitution is a measure of responsiveness of the growth rate of consumption to the real interest rate. How ever, the use of micro data involves serious problems. Our result provides a theoretical explanation for these empirical. These notches generate large bunching below the critical ltv thresholds and missing mass above them. The return to wealth, asset pricing, and the intertemporal elasticity. Calibration and simulation of dsge models paul gomme. Estimating intertemporal and intratemporal substitutions when.
Elasticity of intertemporal substitution metaanalysis. In many economic textbooks the constant elasticity of substitution ces utility function is defined as. The intertemporal elasticity of substitution ies is a key parameter that characterizes household consumption and saving behaviour, and it plays a crucial role in determining policy and welfare assessments, where the positive value of the ies is the basic premise of theoretical or quantitative analysis. Elasticity of a function of a single variable before we meet this guest, let us spend a bit of time with a slightly simpler notion, the elasticity of a a function of a single variable. On the intertemporal elasticity of substitution under nonhomothetic utility article in journal of money credit and banking 405. About intertemporal elasticity of substitution microeconomics. The percentage difference in labor supply at time t on path i and labor supply at time t on path ii is d2. The inverse of the number is the intertemporal elasticity of substitution. Intertemporal and intratemporal substitution, and the speed. Production functions with a constant elasticity of substitution ces have been used extensively in. In all common models of intertemporal allocation, the assumption of a constant elasticity of intertemporal substitution eis imposes surprising limitations on withinperiod budget allocations.
In general, preferences over consumption bundles at different points in time should be represented by a utility function of the form 1. Estimating the intertemporal substitution elasticity. Thanks for contributing an answer to economics stack exchange. The third panel in table 2 performs a similar exercise, this time holding the intratemporal elasticity of substitution in consumption at its benchmark value. The intertemporal elasticity of substitution of consumption ies plays a key role in innumerable policy evaluations. The intertemporal elasticity of substitution between dates i and j is an evaluation of 2. The elasticity of intertemporal substitution eis measures the willingness on the part of the consumer to substitute future consumption for present consumption. The intertemporal elasticity of substitution thus represents the proportional change in consumption that must follow to a one percent change in the interest rate in order to keep the. Intertemporal substitution in consumption robert e.
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