Working Paper: NBER ID: w2265
Authors: Robert E. Hall
Abstract: Macroeconomic research on consumption has been influenced profoundly by rational expectations. First, rational expectations together with the hypothesis of constant expected real interest rates implies that consumption should evolve as a random walk. Much of the research of the past decade has been devoted to testing the random walk hypothesis and to explaining its failure. Three branches of the literature have developed. The first relies on the durability of consumption to explain deviations from the random walk property. The second invokes liquidity constraints which block consumers from the credit market transactions needed to make consumption follow a random walk when income fluctuates up and down. The third branch dispenses with the assumption that expected real interest rates are constant. It attempts to explain deviations from the random walk in terms of intertemporal substitution.
Keywords: Consumption; Rational Expectations; Euler Equation
JEL Codes: D91; E21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Income (D31) | Consumption (E21) |
| Liquidity Constraints (E41) | Consumption (E21) |
| Durability of Consumption Goods (E21) | Consumption Predictability (E21) |
| Expected Real Interest Rates (E43) | Consumption (E21) |