Rotterdam Brown Bag Seminars General Economics

Lorenzo Pozzi (Erasmus University Rotterdam)
Wednesday, 25 October 2017

The most common approach to determine the long-run impact of household wealth on household consumer expenditures is to estimate a log-linear version of the household intertemporal budget constraint as a cointegrating relationship. The evidence in favor of a stable cointegrating relationship between consumption, assets and earnings in the US and in other countries is weak however. Hence, elasticity estimates based on such regressions are unreliable. This paper follows an alternative empirical approach using an unobserved component model applied to US data over the period 1951Q4-2016Q4. The regression of consumption on assets and earnings is augmented with a non-stationary unobserved component. By explicitly estimating – hence controlling for – such a component in the regression, valid long-run elasticity estimates of consumption to wealth can be obtained irrespective of whether consumption, assets and earnings are cointegrated. The results suggest that ignoring the non-stationary latent component in the consumption regression overestimates the effect on consumption of both financial and housing wealth. Joint work with Malin Gardberg.