Working Paper: CEPR ID: DP12812
Authors: Florin Ovidiu Bilbiie
Abstract: In business-cycle, macro models the elasticity of intertemporal substitution (EIS) governs the economy's response to demand shocks and policy changes ("multipliers"). With general non-separable preferences, the EIS is determined by consumption-hours complementarity and the income effect on hours. Complementarity helps generate business-cycle co-movement following demand shocks, fiscal multipliers, and allows reconciling low EIS with low income-wealth effects. Yet existing utility functions restrict either complementarity, or income effects---or both---and artificially imply that EIS is exclusively a function of either. I propose a novel utility function where both complementarity and the income effect are arbitrary and can be calibrated separately.
Keywords: Consumption-Hours Complementarity; Business-Cycle Comovement; Income and Wealth Effects; Elasticity of Intertemporal Substitution; Fiscal Multipliers; News Shocks
JEL Codes: D11; E21; E62; H31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| elasticity of intertemporal substitution (EIS) (D15) | income effect (D12) |
| elasticity of intertemporal substitution (EIS) (D15) | consumption-hours complementarity (D10) |
| income effect (D12) | elasticity of intertemporal substitution (EIS) (D15) |
| consumption-hours complementarity (D10) | elasticity of intertemporal substitution (EIS) (D15) |
| elasticity of intertemporal substitution (EIS) (D15) | response to demand shocks (E39) |
| elasticity of intertemporal substitution (EIS) (D15) | response to policy changes (J18) |
| consumption-hours complementarity (D10) | effect of demand shocks (E32) |
| elasticity of intertemporal substitution (EIS) (D15) | business cycle facts (E32) |