High Intertemporal Elasticity Of Substitution Research Articles

Who Are the Hand-to-Mouth?

Abstract Many households hold little wealth. In standard precautionary savings models, these households should not only display higher marginal propensities to consume (MPCs) but also higher future consumption growth. In contrast, we see from the Panel Study of Income Dynamics that such “hand-to-mouth” households do not display higher growth in spending. They also exhibit greater volatility of spending and adjust their spending to a greater extent through the number of categories consumed. Consistent with a role for preference heterogeneity, the panel data show that it is persistent differences across households, not current assets, that predict low consumption growth and other spending differences for the hand-to-mouth households. To identify the extent of preference heterogeneity, we consider the model of Kaplan and Violante with both liquid and illiquid assets, but allow heterogeneity in preferences. To match the data, many poor hand-to-mouth must be relatively impatient and have a high inter-temporal elasticity of substitution. The model shows that preferences predominantly explain the higher MPCs for low-asset households. Preference heterogeneity notably increases the spending impact of fiscal transfers, but only if targeted, while reducing that from interest rate cuts.

Belief-driven growth slowdowns and zero-bounded risk-free rate

The literature presents mounting evidence that global long-run growth has been declining since the recession of 2008. Thus, to explore possible reasons for the growth slowdown and its risk-free rate and risk premium implications, this study constructs an endogenous growth model to examine the US economy before the 2008 recession and during the subsequent recovery period. The model features technological externalities that imply multiple perfect foresight balanced growth paths. In this setup, a change in agents’ beliefs may trigger persistent slumps, low interest rates, and elevated risk premium, consistent with the recent US experience. Numerically, using the Epstein and Zin preferences, the model calibration suggests that the historical data moments can be accommodated by persistent regimes and high intertemporal elasticity of substitution. Notably, the study’s simple-structured model with multiplicity and a regime-switching structure is a preliminary contribution to the field of economics, paving the way for future empirical studies.

Asset bubble and endogenous labor supply: A clarification

This paper analyzes the link between asset bubbles, endogenous labor and capital. First, we explicitly and theoretically derive the conditions to have a crowding-in effect of the bubble, i.e. higher levels of capital and labor. Second, the utility function we consider shows that this result does not require an arbitrarily high elasticity of intertemporal substitution in consumption.

Indeterminate equilibrium growth with product and R&D spillovers

The paper revisits an endogenously growing economy à la Romer (1990) to explore the possibility of local and global indeterminacy where, along with the usual R&D spillover, a manufacturing sector generates a product spillover on R&D. When the product spillover facilitates R&D, the dynamic market equilibrium is unique and determinate. However, when the product spillover is strongly negative on R&D, multiple balanced market equilibria emerge and are therefore globally indeterminate. Furthermore, global indeterminacy coexists with local indeterminacy under the joint condition on the intertemporal elasticity of substitution of consumption. Local indeterminacy also emerges when the product spillover is mildly negative in tandem with a high intertemporal elasticity of substitution. Hence, a dynamic market economy with product spillovers in the R&D sector enriches the understanding of observable growth phenomena, including business and growth cycles and income and growth disparity, among countries with the same economic fundamentals.

A Tax-Based Estimate of the Elasticity of Intertemporal Substitution

One of the most important behavioral parameters in macroeconomics is the elasticity of intertemporal substitution (EIS). Starting with the seminal work of Hall (Hall, R., 1978, Stochastic Implications of the Life Cycle — Permanent Income Hypothesis: Theory and Evidence, Journal of Political Economy 86, 971–987), researchers have used an Euler equation framework to estimate the EIS, relating the growth rate of consumption to the after-tax interest rate facing consumers. This large literature has, however, produced very mixed results, perhaps due to an important limitation: The impact of the interest rate on consumption or savings is identified by time-series movements in interest rates. Yet the factors that cause time-series movements in interest rates may themselves be correlated with consumption or savings decisions. I address this problem by using variation across individuals in the capital income tax rate. Conditional on observable characteristics of individuals, tax rate movements cause exogenous shifts in the after-tax interest rate. Using data on total non-durable consumption from the Consumer Expenditure Survey over two decades, I estimate a surprisingly high EIS of two. This finding is robust to a variety of specification checks.

Information Quality and Stock Returns Revisited

AbstractThis paper investigates the relation between information on the state of the economy and equity risk premium. We use a setup where investors have Epstein-Zin preferences and the economy randomly switches between booms and recessions. We are able to establish 2 key results: First, investors with high elasticity of intertemporal substitution (EIS) will require lower excess returns for holding stocks if they are provided with better information on the state of the economy. Second, we find that this also holds for investors with moderate EIS if they are sufficiently risk averse.

Poverty traps and intergenerational transfers

In this paper, by adopting an OLG neoclassical growth model, we show that intergenerational transfers may trigger the take off of an economy entrapped into poverty in a twofold way: (1) by eliminating the zero equilibrium, which, under technology with low factor substitutability, is always a “catching” point, so that the economy might start converging to a positive equilibrium. In this case, the appropriate instrument turns out to be a transfer from the old to the young, while there is no room for policies redistributing in the opposite direction (i.e., a pay-as-you-go pension scheme); (2) when the rich equilibrium is unstable—which can be the case under high intertemporal elasticity of substitution of individuals—the introduction of transfers may stabilize such an equilibrium, so that the economy starts converging to it. In the latter case, both policy programs such as pay-as-you-go pension schemes or subsidies to the young may help escaping from poverty. However, we point out that in either circumstance, the “size” of transfers should be sufficiently large (and, as for pensions, not even too large), in order to avoid ineffective and useless burden on the taxpayers without triggering the take off.

A Model of Exchange-Rate-Based Stabilization for Turkey

The literature on the exchange-rate-based stabilization has focused almost exclusively in Latin America. Many other countries however, such as Egypt, Lebanon and Turkey; have undertaken this sort of programs in the last 10-15 years. I depart from the existing literature by developing a model specifically for the 2000-2001 heterodox exchange-rate-based stabilization program in Turkey: When the government lowers the rate of crawl, the rate of domestic credit creation is set equal to the lower rate of crawl, bond sales finance the fiscal deficit, and money growth occurs only through capital inflows. Without appealing to high intertemporal elasticity of substitution, the model does very well at replicating the magnitude of the current account deficit (5.5% of GDP predicted vs. 5% of GNP actual), the peak in total consumption spending (10.08% predicted vs. 9.6% actual), average growth rate in total consumption spending (6.7% predicted vs. 6% actual), the peak in durables spending (37.06% predicted vs. 39.5% actual), and the average growth rate in durables spending (24% predicted vs. 27.4% actual) observed in Turkey following the inception of the program.

Information Quality and Stock Returns Revisited

We investigate the relationship between the information on the state of the economy and equity risk premium. In this, we use a setup where investors have Epstein-Zin preferences and the economy switches between booms and recessions randomly. We are able to establish two key results: First, we demonstrate that investors with high Elasticity of Intertemporal Substitution will require lower excess returns for holding stocks if they are provided with better information on the state of the economy. Second, we find that this will also hold for investors with a moderate Elasticity of Intertemporal Substitution if they are sufficiently risk averse.

TECHNOLOGY, PREFERENCE STRUCTURE, AND THE GROWTH EFFECT OF MONEY SUPPLY

This paper studies the growth effect of money supply in the presence of increasing returns and endogenous labor supply. By using a simple model of endogenous growth with a cash-in-advance constraint, it is shown that the growth effect of money supply depends on the specifications of preference structures as well as of the production technology. Either if the production technology exhibits strong nonconvexity or if the utility function has a high elasticity of intertemporal substitution, then there may exist dual balanced-growth equilibria and the impact of a change in money growth depends on which steady state is realized in the long run. It is also shown that there is no systematic relationship between the growth effect of money supply and local determinacy of the balanced growth path.

Predictability in Consumption Growth and Equity Returns: A Bayesian Investigation

We use a Bayesian method to estimate a consumption-based asset pricing model featuring long-run risks. Although the model is generally consistent with consumption and dividend growth moments in annual data, the conditional mean of consumption growth (a latent process) is not persistent enough to satisfy the restriction that the price-dividend ratio be an affine function of the latent process. The model also requires relatively high intertemporal elasticity of substitution to match the low volatility of the risk-free return. These two restrictions lead to the equity volatility puzzle. The model accounts for only 50% of the total variation in asset returns.

Persistence of business cycles in multisector real business cycle models

In this paper we explore whether the changing composition of output in response to technology shocks can play a significant role in the propagation of shocks over time. For this purpose we study two multisector real business cycle models, with two and three sectors. We find that, although the two‐sector model requires a high intertemporal elasticity of substitution of consumption to match the various dynamic properties of US macroeconomic data, the three‐sector model has a strong propagation mechanism under conventional parameterizations, as long as the factor intensities in the three sectors are different enough.

Does utility curvature matter for indeterminacy?

Several recent papers have argued that it is more likely for indeterminacy to occur under a high intertemporal elasticity of substitution in consumption. This paper claims that this property does not generally hold in neoclassical growth models. We illustrate this claim by combining the features of those recent papers.

Intertemporal Labor Supply and Human Capital Accumulation*

We solve and estimate a dynamic model that allows agents to optimally choose their labor hours and consumption and that allows for both human capital accumulation and savings. Estimation results and simulation exercises indicate that the intertemporal elasticity of substitution is much higher than the conventional estimates and the downward bias comes from the omission of the human capital accumulation effect. The human capital accumulation effect renders the life‐cycle path of the shadow wage relatively flat, even though wages increase with age. Hence, a rather flat life‐cycle labor supply path can be reconciled with a high intertemporal elasticity of substitution.

Dynamic Laffer curves

In an endogenous growth model with human capital accumulation, we discuss the possibility of welfare improving changes on the fiscal policy stance in some actual economies. First, we characterize the extent to which the initial fall in revenues produced by a permanent tax cut can be compensated by an increase in the tax base, due to a dynamic Laffer curve effect, showing that there is, in fact, a non-trivial margin for substituting debt for taxes on labor and capital income. Second, we show that the largest feasible reduction in labor income tax rates may easily produce a higher welfare gain than the largest feasible reduction in capital income tax rates. Two qualifications: (a) feasible tax cuts exist only for a relatively high elasticity of intertemporal substitution of consumption, and (b) the preference for the largest feasible tax cut on labor income rather than that on capital income reverses for a low appreciation for leisure, relative to consumption, in the preferences of the representative agent.

Intertemporal substitution and the liquidity effect in a sticky price model

The liquidity effect, defined as a decrease in nominal interest rates in response to a monetary expansion, is a major stylized fact of the business cycle. This paper first confirms that, with separable preferences, a low degree of intertemporal substitution in consumption is a necessary condition for the existence of the liquidity effect. In contrast to this result, in a model with non-separable preferences and capital accumulation it takes an implausibly high elasticity of intertemporal substitution to produce a liquidity effect. The robustness of these results to alternative degrees of nominal rigidities, capital adjustment costs and stochastic monetary processes is also analysed. We conclude that price stickiness, by itself, does not guarantee the existence of a liquidity effect.

Monopolistic competition, indeterminacy and growth

Summary In this paper we analyse the dynamics of both Romer's original model of endogenous growth and of a modified version where the level of labour and human capital are determined endogenously. We find that the original model can have an indeterminate Balanced Growth Path (BGP) if there is some degree of complementarity between the intermediate inputs, and if agents have a high intertemporal elasticity of substitution of consumption. Once we allow for the endogenous determination of labour and of total human capital, we find that equilibrium can be indeterminate with a much lower elasticity of intertemporal substitution of consumption. Moreover, if some modest increasing returns are introduced into the production function for human capital, the issue of global as opposed to local indeterminacy arises: this refers to situations when there exist multiple determinate BGPs, but where the global dynamics is still indeterminate from given initial conditions.

Non-Traded Goods and the International Transmission of Fiscal Policy

.Abstract. This paper looks at the effect of non-traded goods on the international transmission of fiscal policy. Intertemporal movements in the price of non-traded goods affect real interest rates differentially between countries. The real interest rate effects of a fiscal expansion depend crucially upon both the composition of fiscal spending and the intertemporal elasticity of substitution. With a high intertemporal elasticity of substitution in consumption, a temporary fiscal expansion on non-traded goods will lead consumer real interest rates to move in opposite directions between countries.