Requiem for the Representative Consumer? Aggregate Implications of Microeconomic Consumption Behavior by Christopher D. Carroll. Published in volume 90, issue 2, pages 110-115 of American Economic Review, May 2000

This paper estimates the degree of stickiness in aggregate consumption growth (sometimes interpreted as reflecting consumption habits) for thirteen advanced economies. We find that after controlling for measurement error, consumption growth has a high degree of autocorrelation, with a stickiness parameter of about 0.7 on average across countries. The sticky consumption growth model outperforms the random walk model of Hall (1978) and typically fits the data better than the popular Mankiw (1989) model, though in a few countries, the sticky consumption growth and Campbell-Mankiw models work about equally well.

At least since Keynes (1935), many economists have had the intuition that the marginal propensity to consume out of wealth declines as wealth increases. Nonetheless, standard perfect-certainty and certainty equivalent versions of intertemporal optimizing models of consumption imply a marginal propensity to consume that is unrelated to the level of household wealth. We show that adding income uncertainty to the standard optimization problem induces a concave consumption function in which, as Keynes suggested, the marginal propensity to consume out of wealth or transitory income declines with the level of wealth.

We estimate how much of the wealth of a sample of respondents to the Panel Study of Income Dynamics is held because some households face more income uncertainty than others. We begin by solving a theoretical model of saving, which we use to develop appropriate measures of uncertainty. We then regress households' wealth on our measures of uncertainty, and find substantial evidence that households engage in precautionary saving. Finally, we simulate the wealth distribution that our empirical results imply would prevail if all households had the same uncertainty as the lowest uncertainty group. We find that between 32 and 50% of wealth in our sample is attributable to the extra uncertainty that some consumers face compared to the lowest uncertainty group.

Using a standard, realistically calibrated model of buffer-stock saving with transitory and permanent income shocks, we study how cross-country differences in the wealth distribution and household income dynamics affect the marginal propensity to consume out of transitory shocks (MPC). Across the 15 countries in our sample, we find that the aggregate consumption response ranges between 0.1 and 0.4 and is stronger (i) in economies with large wealth inequality, where a larger proportion of households has little wealth, (ii) under larger transitory income shocks, and (iii) when we consider households only use liquid assets (rather than net wealth) to smooth consumption.

This paper examines precautionary behavior by relating job-loss risk to household net worth. We use existing best practice and some new strategies to deal with some problematic issues inherent in this literature regarding proxying uncertainty, instrumentation, and incorporating theoretical restrictions. We do not find precautionary variation in the wealth holdings of households with low permanent income, but do find precautionary effects for moderate and higher-income households. When the dependent variable is total net worth, these findings are robust to several alternative specifications. But we do not find precautionary responses in subaggregates of wealth that exclude home equity.

Saving and growth are strongly positively correlated across countries. Recent empirical evidence suggests that this correlation holds largely because high growth leads to high saving, not the other way around. This evidence is difficult to reconcile with standard growth models, since forward-looking consumers with standard utility should save less in a fast-growing economy because they know they will be richer in the future than they are today. We show that if utility depends partly on how consumption compares to a “habit stock” determined by past consumption, an otherwise-standard growth model can imply that increases in growth can cause increased saving. (JEL D91, E21, O40)

In the three months following the Iraqi invasion of Kuwait, the University of Michigan's Index of Consumer Sentiment (ICS) fell an unprecedented 24.3 index points, to its lowest level since the 1981-1982 recession.' This collapse in household confidence became the focus of a great deal of economic commentary and, indeed, frequently was cited as an important-if not the leading-cause of the economic slowdown that ensued. Concern was fueled by the well-known contemporaneous correlation between the ICS and the growth of household spending. Figure 1 shows quarterly averages of the index, 1978-1993, together with the quarterly growth in real personal consumption expenditures as measured in the national income accounts (Bureau of Economic Analysis). The correlation is impressive. Of course, it is not surprising that sentiment and the growth of spending are positively correlated. This correlation may simply reflect that, when economic prospects are poor, households curtail their spending and also give gloomy responses to interviewers. Thus, the contemporaneous correlation between sentiment and spending does not refute traditional life-cycle or permanentincome models of consumption. Nor does it necessarily make the job of forecasting changes in consumption any easier. From the point of view of an economic forecaster, the questions of interest are first, whether an index of consumer sentiment has any predictive power on its own for future changes in consumption spending, and second, whether it contains information about future changes in consumer spending aside from the information contained in other available indicators. In Section I, we present evidence that the answer to the first question is a clear yes: we find that lagged values of the ICS, taken on their own, explain about 14 percent of the variation in the growth of total real personal consumption expenditures over the post1954 period. Further investigation shows that the answer to the second question is probably yes as well, though here the margin is narrower and the evidence more murky. The ICS contributes about 3 percent to the R2 of a simple reduced-form equation for total personal consumption expenditures in the longer of the two sample periods we examine, but nothing in the shorter sample period (though the latter result is heavily influenced by the observation for 1980:2). For the major subcategories of spending, the contribution generally ranges between 1 percent and 8 percent. Overall, we read the evidence as pointing toward at least some significant incremental explanatory power. Therefore, we take as given for the remainder of the paper that sentiment forecasts spending, and we turn to the issue of how that statistical relationship should be interpreted. One possible interpretation is that sentiment is an independent driving factor in the economy, and that changes in * Carroll: Division of Research and Statistics, Stop 80, Federal Reserve Board, Washington, DC 20551: Fuhrer: Research Department, Federal Reserve Bank of Boston, Boston, MA 02106: Wilcox: Division of Monetary Affairs, Stop 71, Federal Reserve Board, Washington, DC 20551. We have benefited from the research assistance of Stephen Helwig and Christopher Geczy and the comments of an anonymous referee. The views expressed in this paper are those of the authors and not of the Federal Reserve Board, the Federal Reserve Bank of Boston, or the other members of the staff of either institution. IThe Conference Board's Consumer Confidence Index also plunged at the same time.