Euler Equations, Subjective Expectations and Income Shocks

44 Pages Posted: 6 Apr 2017

See all articles by Orazio Attanasio

Orazio Attanasio

University College London - Department of Economics; Institute for Fiscal Studies (IFS); Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Agnes Kovacs

University of Oxford - Department of Economics

Krisztina Molnar

Norwegian School of Economics (NHH) - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: January 12, 2017

Abstract

In this paper, we make three substantive contributions: first, we use elicited subjective income expectations to identify the levels of permanent and transitory income shocks in a life-cycle framework; second, we use these shocks to assess whether households' consumption is insulated from them; third, we use the shock data to estimate an Euler equation for consumption. We find that households are able to smooth transitory shocks, but adjust their consumption in response to permanent shocks, albeit not fully. The estimates of the Euler equation parameters with and without expectational errors are similar, which is consistent with rational expectations. We break new ground by combining data on subjective expectations about future income from the Michigan Survey with micro data on actual Income from the Consumer Expenditure Survey.

Keywords: life cycle models; estimating Euler Equations; survey expectations

JEL Classification: C13; D12; D84; D91; E21

Suggested Citation

Attanasio, Orazio and Kovacs, Agnes and Molnar, Krisztina, Euler Equations, Subjective Expectations and Income Shocks (January 12, 2017). NHH Dept. of Economics Discussion Paper No. 05/2017. Available at SSRN: https://ssrn.com/abstract=2947797 or http://dx.doi.org/10.2139/ssrn.2947797

Orazio Attanasio

University College London - Department of Economics ( email )

Gower Street
London WC1E 6BT, WC1E 6BT
United Kingdom
+44 20 7679 5880 (Phone)
+44 20 7916 2775 (Fax)

Institute for Fiscal Studies (IFS)

7 Ridgmount Street
London, WC1E 7AE
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Agnes Kovacs

University of Oxford - Department of Economics ( email )

10 Manor Rd
Oxford, Oxfordshire OX1 3UQ
United Kingdom

Krisztina Molnar (Contact Author)

Norwegian School of Economics (NHH) - Department of Economics ( email )

Helleveien 30
N-5035 Bergen
Norway

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