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Title: |
'Risky Habits' and the Marginal Propensity to Consume Out of Permanent
Income, or, How Much Would a Permanent Tax Cut Boost Japanese
Consumption? |
| Author: |
Carroll, Christopher D. |
| Author
Affiliation: |
Johns Hopkins U |
| Source: |
International Economic Journal, Winter 2000, v. 14, no. 4, pp. 1-40 |
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Publication Date: |
Winter 2000 |
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Abstract: |
Papers in a variety of disparate
literatures have recently suggested that habit formation in consumption
may explain several empirical puzzles, ranging from the level and
cyclical variability of the equity premium (Abel, 1990, 1999;
Constantinides, 1990; Jermann, 1998; Campbell and Cochrane, 1999) to the
"excess smoothness" of aggregate consumption (Fuhrer, 2000) to the
apparent fact that increases in economic growth cause subsequent
increases in aggregate saving rates (Carroll and Weil, 1994; Bosworth,
1993; Attanasio, Picci, and Scorcu, 2000; Rodrik, 1999; Loayza, Schmidt-Hebbel,
and Serven, 2000). This paper examines an implication of these models
that has mostly been overlooked: habits strong enough to solve these
puzzles imply an immediate marginal propensity to consume out of
permanent shocks of much less than one. When the model is calibrated to
roughly match the rise in the Japanese saving rate over the postwar
period, it implies that the immediate MPC out of permanent tax cuts may
be as low as 30 percent, suggesting that calls for a permanent income
tax cut as a quick means of stimulating aggregate demand in Japan may be
misguided. |
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