Consumption Smoothing Behavior Research Articles

Intertemporal elasticity of substitution with leisure margin

This paper investigates households’ consumption smoothing behavior by estimating the intertemporal elasticity of substitution of consumption (IES) while allowing labor/leisure to vary. To this end, we adopt a utility specification that allows non-separability between consumption and leisure. Using this specification, we define a leisure margin as the gap between the IES that allows leisure to vary and the IES that keeps leisure constant. We find a positive and statistically significant leisure margin throughout the paper. In addition, the leisure margin becomes larger when the spouse’s leisure is taken into consideration. This result indicates that family labor supply plays an important role in households’ consumption decisions. We further explore the heterogeneous nature of nonmarket time, and show that consumption-leisure substitutability could be explained largely by home production. Our findings demonstrate the importance of time allocation when individuals make decisions on consumption and saving.

Linking U.S. State-level housing market returns, and the consumption-(Dis)Aggregate wealth ratio

Using state-level data for the U.S. housing market over the period of 1975:Q1-2012:Q2, we show that the consumption-wealth ratios derived from aggregate wealth (cay) and disaggregate (i.e. financial and housing) wealth (cday) are strong predictors of real housing returns (and their volatility). Additionally, we find that, barring the extreme ends of their respective conditional distributions, such effect is stronger for housing return volatility than housing returns. All in all, our findings show that state-level regressions can recover a large degree of heterogeneity that country-level exercises typically ignore. Such heterogeneity is prominent not only in terms of consumption smoothing behavior, but also with regard to housing return predictability.

Price Dynamics and Consumption Smoothing in Experimental Asset Markets

We report the results of an experiment designed to study the determinants of asset price movement and consumption smoothing behavior across asset markets populated with varying proportion of traders with and without having induced motive to smooth consumption. Although the asset is over-priced compared to the risk-neutral fundamental value in all sessions, the extent of over-pricing and magnitude of price movement is significantly higher when traders with no induced motive to trade are present. We also find that the price of the asset co-moves with the dividend state, with price predictability being higher in the presence of traders with induced motive to smooth consumption. Participants motivated to minimize consumption fluctuations are able to do so with the inclination being more for those having lower initial endowment. With fixed prices, traders are able to smooth consumption not only over periods but also over the dividend states.

Skill-biased technological change and homeownership

In the United States, the residential housing market went through important changes over the period from the 1970s to the mid-1990s. Although the aggregate homeownership rate was relatively stable during that period, the distribution of homeownership rates by age changed in remarkable ways. While younger households saw substantial declines in homeownership rates, the opposite happened for older households. In this paper, we argue that the skill-biased technological change (SBTC) that began during the 1970s has been an important factor behind the observed change in the distribution of homeownership rates by age. We build a life cycle model in which skills are accumulated on-the-job through experience: learning by doing. Early in life, households have lower levels of skills and therefore lower earnings. SBTC increases the returns to skill, widening the wage gap between young and old ages. As a consequence, it takes more time for young households to become homeowners given frictions in financial markets (e.g. downpayment requirements) and housing markets (e.g. large and indivisible houses), in line with consumption smoothing behavior. On the other hand, older households that could not afford a house before may now become homeowners, given higher returns to skill. Our analysis confirms this conjecture, namely, that SBTC shifts the distribution of homeownership from the young to the old.

Noise traders, exchange rate disconnect puzzle, and the Tobin tax

This paper proposes a framework to explain the “exchange rate disconnect puzzle”. Two types of foreign exchange traders, rational traders and noise traders are introduced into a sticky-price general-equilibrium model. The presence of noise traders creates deviations from the uncovered interest parity. Combined with local currency pricing and consumption-smoothing behavior, our model can help to explain the “disconnect puzzle”. The excess exchange rate volatility caused by noise traders can be reduced by the ‘Tobin tax’. However, the effect of the ‘Tobin tax’ depends on the market structure and the interaction between the Tobin tax and other trading costs.

Higher-Order Properties of the ‘Exchange Rate Dynamics Redux’ Model

In the `exchange rate dynamics redux' model of Obstfeld and Rogoff (1995, Journal of Political Economy, 103(3), 624---660), the short-run and the long-run changes in the net foreign asset are the same. This equivalence is consistent with the first-order linear approximation of the model; but is inconsistent with the long-run consumption smoothing behavior. This paper extends the "redux" model by approximating the changes in the net foreign asset with the second-order perturbation method. This higher-order approximation illustrates that the equivalence does not hold and the difference between the short-run and the long-run changes is of the second order.

Do High Debt Payments Hinder Household Consumption Smoothing?

Recently, U.S. households have committed a rising share of disposable personal income to required principal and interest payments on household debt. Studies of the direct link between the household debt service ratio (DSR) and consumption show mixed resultsâ perhaps because debt may instead alter the relationship between consumption and income. We explore this possibility by comparing the consumption smoothing behavior of households over the DSR distribution. We find that a high DSR alone does not indicate higher sensitivity of consumption to a change in income. However, we find evidence that the DSR may help identify borrowing constrained households. In particular, the consumption of households with low liquid assets and high DSRs is more sensitive than the consumption of other low liquid asset households. Although this effect of high DSR is not precisely estimated, it is large and robust to changes in the specification, suggesting that more work is warranted.

Do High Debt Payments Hinder Household Consumption Smoothing?

Recently, U.S. households have committed a rising share of disposable personal income to required principal and interest payments on household debt. Studies of the direct link between the household debt service ratio (DSR) and consumption show mixed results—perhaps because debt may instead alter the relationship between consumption and income. We explore this possibility by comparing the consumption smoothing behavior of households over the DSR distribution. We find that a high DSR alone does not indicate higher sensitivity of consumption to a change in income. However, we find evidence that the DSR may help identify borrowing constrained households. In particular, the consumption of households with low liquid assets and high DSRs is more sensitive than the consumption of other low liquid asset households. Although this effect of high DSR is not precisely estimated, it is large and robust to changes in the specification, suggesting that more work is warranted.

Bank Intermediation over the Business Cycle

A model is developed in which banks engage in valued asset transformation by converting illiquid assets (working capital loans) into highly liquid demand deposit accounts that households use for transactions purposes. Consumption-smoothing behavior induces countercyclicality in the degree to which firms rely on bank borrowings to finance their working capital expenses, which is consistent with U.S. data. The importance of financial markets that provide alternative sources of short-term funds to firms is also illustrated. Absent these markets, nominal interest rates become nearly perfectly positively correlated with output, which is counterfactual, and monetary shocks induce (perhaps, artificially) large aggregate employment responses.

The Long-Run Consumption Effects of Earnings Shocks

While prior studies of job displacement and disability have measured the impact of these shocks in terms of lost earnings, there has been no previous research which links these permanent earnings shocks to the long-run consumption smoothing behavior of these households. Since consumption is generally considered a better measure of well-being than income, understanding the link between these earnings shocks and consumption is important in trying to gauge the magnitude of the long-run impact caused by such events. Using the Panel Study of Income Dynamics, the analysis finds the percentage change in consumption is generally less than that of the head's earnings and total family income, especially at the time of the shock. The results also indicate that displaced households respond to an increase in the probability of future job losses by reducing their consumption prior to a job loss. These results suggest that only focusing on earnings will overestimate the impact of these shocks on household well-being.

Are countries with official international restrictions ‘liquidity constrained’?

In this paper, I empirically examine consumption smoothing behavior across a broad group of countries using a unique data set that indicates whether residents in a country face an official government restriction. I then ask whether the ex ante consumption movements among restricted countries differ from those of unrestricted countries. To gauge the departure from standard consumption smoothing, I use the Campbell and Mankiw (‘Consumption income, and interest rates: Reinterpreting the time series evidence’, In: O.J. Blanchard and S. Fischer, eds., NBER macroeconomics annual, 1989 (MIT Press, Cambridge, MA, 1989) and ‘The response of consumption to income: A cross-country investigation’ European Economic Review 35, 723–756, 1991) approach of regressing consumption growth on income growth and instrumenting with lagged variables. Interestingly, I find that consumption growth for residents in countries that impose international restrictions have a significantly higher coefficient on income growth than do residents in countries without those restrictions. Thus, a greater proportion of consumers facing international restrictions appear to act as though they are liquidity constrained according to the Campbell and Mankiw approach. I also discuss alternative interpretations that do not depend upon liquidity constraints.

Expected stock returns, real business activity and consumption smoothing

This paper develops a general equilibrium asset-pricing model that incorporates both production technology and consumption-smoothing behavior. It shows that technology and productivity shocks, labor input and capital stock are important factors in explaining the behavior of expected asset returns. Empirical tests indicate that, while technology shocks and growth in capital stock are significant factors in explaining asset returns, it is the labor growth variable that appears to provide most of the explanatory power. Furthermore, our results indicate that investors are likely to have high levels of relative risk aversion as well as consumption-smoothing behavior.

Consumption Smoothing and Exchange Rate Volatility

This paper analyzes exchange rate behavior in a model where consumers trade goods to diversify shocks to their income. A model with traded and nontraded goods is simulated in a multilateral context based upon historical output correlations for the period 1970–92. Simulation results indicate that the observed volatility of multilateral real exchange rates for the United States, Germany and Japan is not inconsistent with exchange rate volatility implied by consumption-smoothing behavior.

Consumption Smoothing and Exchange Rate Volatility

This paper analyzes exchange rate behavior in a model where consumers trade goods to diversify shocks to their income. A model with traded and nontraded goods is simulated in a multilateral context based upon historical output correlations for the period 1970–92. Simulation results indicate that the observed volatility of multilateral real exchange rates for the United States, Germany and Japan is not inconsistent with exchange rate volatility implied by consumption-smoothing behavior.