Precautionary Saving and Consumption Fluctuations

Woodrow Wilson School Economics Discussion Paper No. 227

35 Pages Posted: 7 Apr 2004

See all articles by Jonathan A. Parker

Jonathan A. Parker

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Bruce J. Preston

Columbia University - Graduate School of Arts and Sciences - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: March 2004

Abstract

This paper uses the consumption Euler equation to derive a decomposition of consumption growth into four sources. These are new information and three sources of predictable consumption growth: intertemporal substitution, changes in the preferences for consumption, and incomplete markets for consumption insurance. Using data on the expenditures of households, we implement the decomposition for the average growth rate of consumption expenditures on nondurable goods in the U.S. from the beginning of 1982 to the end of 1997. Incomplete markets for trading consumption in future states lead to statistically significant and countercyclical movements in expected consumption growth: consumption growth is expected to be higher when the unemployment rate is high. 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.

Keywords: Incomplete markets, precautionary saving, permanent income hypothesis, business cycles, consumption smoothing, Euler equation

JEL Classification: E21, E32, D12

Suggested Citation

Parker, Jonathan A. and Preston, Bruce J., Precautionary Saving and Consumption Fluctuations (March 2004). Woodrow Wilson School Economics Discussion Paper No. 227, Available at SSRN: https://ssrn.com/abstract=525063 or http://dx.doi.org/10.2139/ssrn.525063

Jonathan A. Parker (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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National Bureau of Economic Research (NBER)

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Bruce J. Preston

Columbia University - Graduate School of Arts and Sciences - Department of Economics ( email )

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New York, NY 10027
United States

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