Intratemporal Substitution Research Articles

CONSUMPTION TAX CUTS IN A RECESSION

AbstractI study the effectiveness of temporary cuts to consumption tax rates as fiscal stimulus instruments during recessions using a structural life‐cycle model with multiple consumption categories. I find tax elasticities of 0.4 for nondurable luxuries and of 10.5 for durables. I show that the tax cut on nondurables has an intratemporal substitution effect, whereas the tax cut on durables acts through an intertemporal substitution mechanism that is stronger for high‐income, liquidity‐unconstrained, and younger households. This mechanism is amplified in less persistent recessions and dampened in absence of recessions due to durables' partial irreversibility and precautionary saving motives.

Peasant farmers and pandemics: the role of seasonality and labor-leisure trade-off decisions in economy-wide models

Pandemics attack the primary asset (labor) of peasant households and the rural poor. Peasant households must simultaneously allocate labor between farm and household activities, where the demand for agricultural labor is seasonal, which limits intra-temporal substitution, without perfect foresight. A pandemic reduces the supply of labor, through deaths and morbidity, with the scale of reductions in labor supply depending on the seasons in which a pandemic occurs. The analyses, using a recursive dynamic economy-wide model for Bhutan, demonstrate that outbreaks in high labor demand seasons cause increases in wage rates almost three times as high as for outbreaks in low labor demand seasons. Increases in wage rates induce peasant households to reallocate labor time between farm and household activities through the labor-leisure trade-off mechanism. Such changes in the allocation of labor time are important elements of peasants’ mitigation responses, and can reduce the negative economic implications of a pandemic.

Housing prices and trade surpluses in China: An inter-temporal approach

This paper develops an inter-temporal current account model to study the impacts of expected rising housing prices on trade surpluses in China. The model shows two channels working in opposite directions. The first channel is the intra-temporal substitution channel. It discourages current consumption of tradable goods, leading to trade surpluses. The second is the inter-temporal substitution channel, which instead leads to trade deficits. When intra-temporal channel dominates, expected rising housing prices lead to trade surpluses. However, borrowing constraints on housing purchases may weaken the intra-temporal substitution channel and thus weaken the positive correlation between expected housing prices and trade surpluses. We show empirically that expected rising housing prices lead to trade surpluses in China. We also identify possible reason for this finding: strong intra-temporal substitution elasticity due to large male to female sex ratio in China. We further show that the positive relation between expected rising housing prices and trade surpluses is weaker in regions with more stringent borrowing constraints, consistent with our model’s prediction.

International reserves: self-insurance and monetary policy in crisis

PurposeThis work presents a model of a two-period economy to discuss the link between the precautionary motivation for holding international reserves and the country's monetary policy concerns due to a crisis.Design/methodology/approachThere are two possible states of nature in the second period of the economy: a normal state and a crisis state. These states of nature represent uncertainty to the policy maker and he can insure against a crisis. The household has a constant-elasticity-of-substitution (CES) utility function, where utility depends on consumption and money.FindingsBy allowing money in the utility function and in the household financial constraint and considering that the objective of the central bank is to smooth inflation, it is concluded that monetary policy plays a role in the precautionary motivation of holding international reserves.Practical implicationsThe model can be used to calculate optimal reserves holdings in its complete or even in its simplified version. Furthermore, it is possible to evaluate the impact of the intra-temporal substitution elasticity between consumption and real money in the decision of accumulating international reserves.Originality/valueHigher intra-temporal substitution elasticities implies in more insurance via international reserves, and this discussion is not found in the existent literature on international reserves.

Productivity and welfare in an overlapping generations model with housing

Productivity and welfare can have an inverse relationship. This paper describes an overlapping generations model where housing is the savings vehicle, and utility is provided by housing and a consumption good. If intratemporal substitution between the consumption good and housing is sufficiently inelastic, aggregate utility is decreasing in productivity. At higher levels of productivity, the relative scarcity of housing aggravates the problem of oversaving.

Intratemporal nonseparability between housing and nondurable consumption: Evidence from reinvestment in housing stock

Using the data on maintenance expenditures and self-assessed house value, I separate the measure of individual housing stock and house prices, and use these data for testing whether nondurable consumption and housing are characterized by intratemporal nonseparability in households’ preferences. I find evidence in favor of intratemporal dependence between total nondurable consumption and housing. My findings indicate the elasticity of intratemporal substitution between nondurable consumption and housing is higher than the elasticity of intertemporal substitution for composite consumption bundles. Moreover, assuming CES utility, my results are indicative about complementarity between nondurable consumption and housing in the intratemporal preferences.

Durable Goods, Investment Shocks, and the Comovement Problem

AbstractSticky‐price models suggest that capital investment shocks are an important driver of business cycle fluctuations. Despite quantitative importance in explaining business cycles, a comovement problem emerges because the shocks generate intertemporal substitution effects away from consumption toward investment. This paper resolves the problem by extending the standard sticky‐price model to a two‐sector model with consumer durable services. When durable goods are used as investment in capital and consumer durables, positive capital investment shocks also generate intratemporal substitution effects away from consumer durable services toward nondurable consumption that dominates intertemporal effects. Consequently, consumption increases, and the comovement problem is resolved.

Intratemporal Substitution between Housing and Nondurable Consumption: Evidence from Reinvestment in Housing Stock

I investigate empirically the intratemporal dependence between nondurable consumption and housing. Using the data on maintenance expenditures and self-assessed house value, I separate the measure of housing stock and house prices, and use these data for estimation of the model, which allows for testing whether consumption and housing are characterized by intratemporal nonseparability in the contemporaneous utility. I find evidence in favor of a substitution mechanism between housing and total nondurable consumption. A similar conclusion is reached for some separate consumption categories, such as food, transport, clothing, vacations, and entertainment.

Unconventional Fiscal Policy

Unconventional fiscal policy uses announcements of future increases in consumption taxes to generate inflation expectations and accelerate consumption expenditure. It is budget neutral and time consistent. We provide preliminary evidence for the effectiveness of such policies using changes in value-added tax (VAT) and household survey data for Poland. We find households increased their inflation expectations and willingness to purchase durables before the increase in VAT. Future research has to ensure income, wealth effects, or intratemporal substitution channels cannot explain these results and ideally exploit exogenous variation in VAT in a fixed nominal interest rate environment.

Unconventional Fiscal Policy

Unconventional fiscal policy uses announcements of future increases in consumption taxes to generate inflation expectations and accelerate consumption expenditure. It is budget neutral and time consistent. We provide preliminary evidence for the effectiveness of such policies using changes in value-added tax (VAT) and household survey data for Poland. We find households increased their inflation expectations and willingness to purchase durables before the increase in VAT. Future research has to ensure income, wealth effects, or intratemporal substitution channels cannot explain these results and ideally exploit exogenous variation in VAT in a fixed nominal interest rate environment.

The Intra-Temporal Substitution between Government Expenditure and Private Consumption: Empirical Evidence from Bangladesh

This paper investigates the relationship between government spending and private consumption of Bangladesh over the period 1973-2008. Based on a theoretical model of two-good permanent income which allows for random preference shocks in the consumer’s intra-period utility function, our analysis confirms that there is a cointegration relationship between government expenditure and private consumption. Furthermore, we identify that expansionary government spending incompletely crowds out private consumption with the degree of 0.31. This result suggests that people inversely rearrange their consumption in response to a change in government expenditure over time, although the degree of the response is still weak.

Measuring Intertemporal Substitution in Consumption: Evidence from a VAT Increase in Japan

Abstract We estimate the intertemporal elasticity of substitution in consumption (IES) using a preannounced increase in Japan’s consumption tax rate. Because this tax is highly comprehensive, the rate increase was announced prior to its implementation, and because other factors that affect the real interest rate were constant, the tax rate increase presents an ideal natural experiment to estimate the IES. A Japanese monthly household survey is exploited to accurately categorize nondurables, and our empirical specification addresses intratemporal substitution bias. We find that the IES is 0.21 and not significantly different from 0, but it is significantly less than 1.

The Effect of Unconventional Fiscal Policy on Consumption Expenditure

Unconventional fiscal policy uses announcements of future increases in consumption taxes to generate inflation expectations and accelerate consumption expenditure. It is budget neutral and time consistent. We exploit a unique natural experiment for an empirical test of the effectiveness of unconventional fiscal policy. To comply with European Union law, the German government announced in November 2005 an unexpected 3-percentage-point increase in value-added tax (VAT), effective in 2007. The shock increased households' inflation expectations during 2006 and actual inflation in 2007. Germans' willingness to purchase durables increased by 34% after the shock, compared to before and to matched households in other European countries not exposed to the VAT shock. Income, wealth effects, or intratemporal substitution cannot explain these results.

The Effect of Unconventional Fiscal Policy on Consumption Expenditure

Unconventional fiscal policy uses announcements of future increases in consumption taxes to generate inflation expectations and accelerate consumption expenditure. It is budget neutral and time consistent. We exploit a unique natural experiment for an empirical test of the effectiveness of unconventional fiscal policy. To comply with European Union law, the German government announced in November 2005 an unexpected 3-percentage-point increase in value-added tax (VAT), effective in 2007. The shock increased households' inflation expectations during 2006 and actual inflation in 2007. Germans' willingness to purchase durables increased by 34% after the shock, compared to before and to matched households in other European countries not exposed to the VAT shock. Income, wealth effects, or intratemporal substitution cannot explain these results.

Unconventional Fiscal Policy, Inflation Expectations, and Consumption Expenditure

Unconventional fiscal policies incentivize households to accelerate consumption by generating future consumer price ination, and offer an alternative to unconventional monetary policy (Correia et al. (2013)). We use a natural experiment to study the causal effect of unconventional fiscal policies on consumption expenditure via the inflation-expectations channel. The German administration unexpectedly announced in November 2005 a three-percentage-point increase in value-added tax (VAT) effective in 2007. This shock increased German households’ inflation expectations during 2006, as well as actual inflation in 2007. Matched households in other European countries serve as counterfactuals in a difference-in-differences identification design. German households’ willingness to purchase durable goods increased by 34% after the shock, compared to matched foreign households. Income or wealth effects do not appear to drive these results, and we do not find evidence of intratemporal substitution from non-durable to durable consumption.

Inflation Expectations and Consumption Expenditure

Unconventional fiscal policy uses announcements of future increases in consumption taxes to generate inflation expectations and accelerate consumption expenditure. It is budget neutral and time consistent. We exploit a unique natural experiment for an empirical test of the effectiveness of unconventional fiscal policy. To comply with European Union law, the German government announced in November 2005 an unexpected 3-percentage-point increase in value-added tax (VAT), effective in 2007. The shock increased households' inflation expectations during 2006 and actual inflation in 2007. Germans' willingness to purchase durables increased by 34% after the shock, compared to before and to matched households in other European countries not exposed to the VAT shock. Income, wealth effects, or intratemporal substitution cannot explain these results.

Long-Run Optimization Horizon, Durable Consumption Growth and Estimation of Risk Aversion

We present a durable consumption-based asset pricing model with Epstein-Zin preferences and the pricing kernel accommodating the long-run consumption risk. Consumption growth includes a small predictable component as in Bansal and Yaron (2004). The model is estimated with simple econometric techniques once we linearize it around a special case of the elasticity of inter- and intra-temporal substitution equal to one. After including the long-run consumption growth, the estimates of the model parameters become much more realistic and the fit closer to the data than for the case of the contemporaneous consumption growth. For example, the estimate of risk aversion falls from around 200 to 10, and the R2 increases from around 30% to 60%.

CONSUMPTION, MONEY, INTRATEMPORAL SUBSTITUTION, AND CROSS‐SECTIONAL ASSET RETURNS

AbstractWhen utility is specified recursively as a function of both consumption and money, real money growth becomes a common factor in addition to the market excess return and consumption growth. The risk premium on the money factor is negative because money complements consumption and is positively related to the stochastic discount factor. Growth portfolios, short‐term loser portfolios, and long‐term winner portfolios tend to have higher loadings on the money factor and, thus, earn lower premiums on money.

Price Variability and Savings

We analyze how commodity price variability affects saving behavior in a dynamic model with multiple commodities, portfolio hedging, and a preference structure that disentangles attitudes towards risk and attitudes towards intertemporal substitution. We show that the effect of price variability on savings boils down to knowing 1) the consumer’s degree of aversion to intertemporal fluctuations (i.e. the size of the elasticity of intertemporal substitution) and 2) the effect that price variability has on the certainty-equivalent real interest rate. Price variability is more likely to decrease the certainty-equivalent rate if consumers are highly risk averse, if there is limited intra-temporal substitution among the goods, and if asset returns are a poor hedge against inflation. We also show that if price variability decreases the certainty-equivalent rate, consumer’s welfare also decreases.

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