Precautionary Saving and Consumption Fluctuations
53 Pages Posted: 14 Sep 2002 Last revised: 29 Oct 2010
Date Written: September 2002
This paper uses data on the expenditures of households to explain movements in the average growth rate of consumption in the U.S. from the beginning of 1982 to the end of 1997. We propose and implement a decomposition of consumption growth into series representing four proximate causes. These are new information, and three causes of predictable consumption growth: intertemporal substitution, changes in the preferences for consumption, and incomplete markets for consumption insurance. Incomplete markets for trading consumption in future states leads to statistically significant and countercyclical movements in expected consumption growth. The economic importance of precautionary saving rivals that of the real interest rate, but the relative importance of each source of movement in the volatility of consumption is not precisely measured.
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