Abstract
This paper presents estimates of the consumption Euler equation for Russia. The estimation is based on micro-level panel data and accounts for the heterogeneity of agents? preferences and measurement errors. The presence of multiplicative habits is checked using the Lagrange multiplier (LM) test in a generalized method of moments (GMM) framework. We obtain estimates of the elasticity of intertemporal substitution and of the subjective discount factor, which are consistent with the theoretical model and can be used for the calibration and the Bayesian estimation of dynamic stochastic general equilibrium (DSGE) models for the Russian economy. We also show that the effects of habit formation are not significant. The hypotheses of multiplicative habits (external, internal, and both external and internal) are not supported by the data.
Highlights
Since the advent of the hypotheses of permanent income (Friedman, 1957) and life cycle consumption (Modigliani and Brumberg, 1954), the concept of consumption smoothing is widely used to describe household consumption behavior
This result supports the consumption-smoothing hypothesis and suggests a positive relationship between expected consumption growth and the interest rate in Russia. This value of corresponds to an EIS7 of 4.167 with a 95% asymptotic confidence interval (2.499, 5.834). This estimate of the elasticity of intertemporal substitution (EIS) is much higher than most estimates obtained for the US economy
The EIS confidence interval rejects the hypothesis of the logarithmic utility function (EIS equal to 1), which is usually used to calibrate dynamic stochastic general equilibrium (DSGE) models of the Russian economy
Summary
Since the advent of the hypotheses of permanent income (Friedman, 1957) and life cycle consumption (Modigliani and Brumberg, 1954), the concept of consumption smoothing is widely used to describe household consumption behavior. This framework is based on the assumption that economic agents smooth their spending over time to maximize utility throughout his or her life. Hall’s seminal paper (1978) proposes the idea that aggregate consumption dynamics should be modeled as a first-order condition for the optimal choice of a single, fully rational, and forward-looking representative consumer. The first-order condition for this optimization problem is known as the Euler equation. The results were widely discussed in the literature and became the baseline for contemporary consumption behavior analysis
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