Consumption Heterogeneity in Macroeconomics and Public Finance

Download or read book Consumption Heterogeneity in Macroeconomics and Public Finance written by Alan Kevin Olivi and published by . This book was released on 2019 with total page 206 pages. Available in PDF, EPUB and Kindle. Book excerpt: This thesis consists of three chapters on households' consumption. In the first chapter we study the canonical consumption-savings income-fluctuations problem with incomplete markets and show theoretically how to recover households' preferences and beliefs from their consumption and savings decisions. The main innovation is to show how to use the transitory component of income as an instrument that shifts current consumption without changing beliefs about future stochastic changes in consumption. As such, the transitory component of income, affects consumption growth through an intertemporal smoothing motive with no immediate effect on precautionary savings. With the precautionary motive neutralized, comparing changes in consumption and savings in response to temporary shocks allows us to identify the curvature of marginal utility: when savings respond more than consumption to transitory changes in income, the relative prudence is higher. Additionally, the transitory component makes it possible to identify an effective discount rate, which in turns makes it possible to control the degree of households' impatience. The curvature of marginal utility and the effective discount rate are sufficient to understand how preferences restrict consumption choices through the Euler equation. To then recover beliefs, we assume that beliefs are independent of exogenous changes in assets. This gives us an additional instrument to identify beliefs since the belief system then has to be consistent with the implied savings patterns as assets vary. These two instruments allows us to non parametrically recover preferences and beliefs in a very general framework: we can accommodate multiple consumption items (both durable and non-durable), multiple assets (liquid and illiquid, risky or not), habits, endogenous labor supply and so on. The second chapter builds on the first. We investigate empirically, in data from the PSID and the SIPP, how households' expectations deviate from rationality. Our estimation shows that households are overconfident and overoptimistic. The main source of overconfidence is that households underestimate the frequency of shocks and their optimism is driven by an underappreciation of negative shocks. However, these biases are not homogeneous in the population: they are amplified for lower income households while higher income households' perceptions are closer to rational expectations. These results explain not only the quantitative magnitude of undersaving and overreaction to income shocks, but also why higher income households accumulate disproportionately more wealth. We then explore how these beliefs affect the design of unemployment insurance and the transmission of countercyclical income risk to aggregate demand. In the third chapter, written with Xavier Jaravel, we investigate how to design optimal income redistribution policies when the price of goods is depends on the size of the corresponding markets and different households consume different goods. We introduce Increasing Returns to Scale (IRS) and heterogeneous spending patterns (non-homothetic preferences) into the canonical tax problem of Mirrlees. In this environment, any change in tax policy induces a change in labor supply, hence a change in market size, which translates endogenously into a change in productivity; this productivity response affects consumer prices and sets off another round of labor supply changes, market size changes, productivity changes, further labor supply changes, and so on. We show theoretically how to characterize these general equilibrium effects and we quantify their importance for the optimal tax schedule. The calibrated model matches empirical evidence on IRS as well as the tax schedule, earnings distribution and spending patterns observed in the United States. We establish three main results: (1) the optimal average tax rate is substantially lower on average, falling from about 45% under Constant Return to Scale (CRS) to about 35% with IRS (because IRS increase the efficiency cost of taxation); (2) with IRS and homothetic utility, optimal marginal tax rates are much less progressive than under CRS, and they become regressive above the 65th percentile of the income distribution (because IRS increase the efficiency cost of taxation relatively more for the rich); (3) with IRS and non-homothetic utility, optimal marginal tax rates become more progressive (intuitively, the planner internalizes that the productivity increase that could result from a tax break to the rich has low social value if the rich spend their marginal dollar on products that the poor do not consume much of). These findings indicate the importance of endogenous productivity and non-homotheticities for optimal taxation.