Working Paper: NBER ID: w2496
Authors: Olivier Jean Blanchard; N. Gregory Mankiw
Abstract: This paper discusses the recent research on the consumption function that has attempted to relax the assumption of certainty equivalence. While there remain many open questions, both theoretical and empirical, it is clear that the assumption of certainty equivalence can be misleading. Under more plausible specifications of preferences toward risk, uncertainty lowers the level of consumption, increases the expected rate of growth of consumption, and increases the response of consumption to news about income. Moreover, changes in the amount of uncertainty are a potentially important source of fluctuations in consumption.
Keywords: consumption; uncertainty; certainty equivalence
JEL Codes: D91; E21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increased uncertainty (D89) | Increased expected marginal utility (D11) |
| Increased expected marginal utility (D11) | Increased expected future consumption (D15) |
| Increased uncertainty (D89) | Increased expected future consumption (D15) |
| Increased uncertainty (D89) | Steeper consumption path (D15) |
| Higher coefficients of prudence (D81) | Stronger effect of uncertainty on consumption (D11) |