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Complementarity, Income, and Substitution: A U(C,N) Utility for Macro

Florin Bilbiie

No 12812, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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: business-cycle co-movement; consumption-hours complementarity; elasticity of intertemporal substitution; Fiscal multipliers; income and wealth effects; news shocks (search for similar items in EconPapers)
JEL-codes: D11 E21 E62 H31 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-mac and nep-upt
Date: 2018-03
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