The Time-Series Properties of Aggregate Consumption: Implications for the Costs of Fluctuation

41 Pages Posted: 6 Jun 2005 Last revised: 2 Feb 2010

See all articles by Ricardo Reis

Ricardo Reis

London School of Economics & Political Science (LSE); National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Date Written: May 2005

Abstract

While this is typically ignored, the properties of the stochastic process followed by aggregate consumption affect the estimates of the costs of fluctuations. This paper pursues two approaches to modelling aggregate consumption dynamics and to measuring how much society dislikes fluctuations, one statistical and one economic. The statistical approach estimates the properties of consumption and calculates the cost of having consumption fluctuating around its mean growth. The paper finds that the persistence of consumption is a crucial determinant of these costs and that the high persistence in the data severely distorts conventional measures. It shows how to compute valid estimates and confidence intervals. The economic approach uses a calibrated model of optimal consumption and measures the costs of eliminating income shocks. This uncovers a further cost of uncertainty, through its impact on precautionary savings and investment. The two approaches lead to costs of fluctuations that are higher than the common wisdom, between 0.5% and 5% of per capita consumption.

Suggested Citation

Reis, Ricardo A.M.R., The Time-Series Properties of Aggregate Consumption: Implications for the Costs of Fluctuation (May 2005). NBER Working Paper No. w11297. Available at SSRN: https://ssrn.com/abstract=714069

Ricardo A.M.R. Reis (Contact Author)

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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