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

40 Pages Posted: 6 May 2005

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)

Multiple version iconThere are 2 versions of this paper

Date Written: April 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.

Keywords: Costs of fluctuations; Models of aggregate consumption; Consumption persistence.

JEL Classification: E32, E21, E60

Suggested Citation

Reis, Ricardo A.M.R., The Time-Series Properties of Aggregate Consumption: Implications for the Costs of Fluctuations (April 2005). Available at SSRN: https://ssrn.com/abstract=716243 or http://dx.doi.org/10.2139/ssrn.716243

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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