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Department of Economics, Norwegian School of Economics (NHH) Discussion Paper Series in Economics, Department of Economics, Norwegian School of Economics (NHH)

No 5/2017:
Euler Equations, Subjective Expectations and Income Shocks.

Orazio Attanasio (), Agnes Kovacs () and Krisztina Molnar ()

Abstract: In this paper, we make three substantive contributions: first, we use elicited subjective income expectations to identify the levels of permanent and transitory income shocks in a life-cycle framework; second, we use these shocks to assess whether households' consumption is insulated from them; third, we use the shock data to estimate an Euler equation for consumption. We find that households are able to smooth transitory shocks, but adjust their consumption in response to permanent shocks, albeit not fully. The estimates of the Euler equation parameters with and without expectational errors are similar, which is consistent with rational expectations. We break new ground by combining data on subjective expectations about future income from the Michigan Survey with micro data on actual Income from the Consumer Expenditure Survey.

Keywords: life cycle models; estimating Euler Equations; survey expectations; (follow links to similar papers)

JEL-Codes: C13; D12; D84; D91; E21; (follow links to similar papers)

39 pages, January 12, 2017

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