Sequential optimization, front-loaded information, and U.S. consumption

No 765, Working Paper Series from European Central Bank

Abstract: In an overlapping generations maximization framework with consumers, whose information on uncertain future income realizations is front loaded, a closed form aggregate consumption function with CRRA preferences is derived. To have a closed form solution we assume that consumers solve their inter-temporal optimization problem sequentially. First they assess risk-adjusted life-time wealth and then the optimal consumption path. The derived model captures precautionary saving, which is dependent on the human to non-human wealth ratio. On aggregate level, after accounting for habit formation, the model is able to explain both the short-run (e.g. the excess sensitivity and the excess smoothness puzzle) and long-run stylized facts of the U.S. consumption data. JEL Classification: D11, D12, D82, E21

Keywords: consumption; habit persistence; information; precautionary saving (search for similar items in EconPapers)
Date: 2007-06
Note: 335687
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Citations: View citations in EconPapers (6)

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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:2007765

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