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Habits, Sentiment and Predictable Income in the Dynamics of Aggregate Consumption

Martin Sommer

Macroeconomics from University Library of Munich, Germany

Abstract: This paper explores whether habit formation in the representative agent’s preferences can explain two failures of the standard permanent income model: the sensitivity to lagged consumer sentiment, and to predictable changes in income. I show that in a habit formation model, the sensitivity of consumption to predicted income can be largely reinterpreted as a sluggish response to news. Moreover, the sensitivity of consumption to sentiment reflects the serial correlation in consumption growth generated by habits. The estimated model predicts an immediate (first-quarter) MPC out of a permanent tax cut of only about 30%.

Keywords: Consumer sentiment; excess sensitivity; habit formation; consumption; marginal propensity to consume; tax cuts (search for similar items in EconPapers)
JEL-codes: E10 E21 E62 H31 (search for similar items in EconPapers)
Pages: 28 pages
Date: 2004-08-09
New Economics Papers: this item is included in nep-cbe
Note: Type of Document - pdf; pages: 28
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