Working Paper: CEPR ID: DP8233
Authors: Haroon Mumtaz; Paolo Surico
Abstract: The consumption Euler equation is a building block of modern macro theory. Yet, the existing evidence on aggregate data offers very conflicting results for the estimates of the degree of forward-lookingness and interest rate semi-elasticity. The disappointing performance can be rationalized by estimating an Euler equation in which the parameters are allowed to vary with the state of the economy. The nonlinear method reveals that during periods in which consumption is above its conditional average the estimates of the degree of forward-lookingness and interest rate semi-elasticity are significantly larger (in absolute value) than the estimates associated with periods of below-average consumption. Our evidence is consistent with models of state-dependence or heterogeneity in the discount factor and the elasticity of intertemporal substitution.
Keywords: aggregate consumption; euler equation; heterogeneity; state dependence
JEL Codes: E21; E32; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| backward-looking behavior during below-average consumption (D12) | sensitivity to changes in real interest rate (E43) |
| fully forward-looking behavior during above-average consumption (E21) | sensitivity to changes in real interest rate (E43) |
| high consumption periods (L97) | effectiveness of monetary policy (E52) |
| nonlinear relationship between consumption and interest rates (E21) | state-dependent parameters (C62) |