Subjective Intertemporal Substitution

Abstract

We estimate the elasticity of intertemporal substitution (EIS) — the elasticity of expected consumption growth with respect to variation in the real interest rate — using subjective expectations from the newly released FRBNY Survey of Consumer Expectations (SCE). This dataset is unique, since it includes consumers’ expectations of both consumption growth and inflation, with the latter providing subjective variation in ex ante real interest rates. As a result, we can estimate a subjective version of the consumption Euler equation, without having to take a stand on the process of expectation formation. Our main finding is that this subjective EIS is precisely and robustly estimated to be around 0.8 in the general population, consistent with typical macroeconomic calibrations of the Euler equation. However, we find some evidence that the EIS rises to slightly above one for high-income individuals, consistent with the assumptions in asset pricing models featuring long-run risks or rare disasters.