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Content archived on 2024-05-14

Optimal Consumption under Precautionary Savings: A Dynamic Heterogeneous Panel Approach


Research objectives and content

Research aimed at understanding the consumption and savings decisions of households and their implications for aggregate cyclical fluctuations as well as aggregate long-run growth has been a cornerstone of theoretical and empirical economic investigations for many decades. There are few, if any, economic issues that have more tar reaching consequences than how households provide for their futures through savings, savings that in turn help finance the accumulation of capital by firms, and thus are critical for countries welfare levels in the long run. In the words of the Nobel laureate Robert Lucas, once one starts to think out (these issues), it is hard to think out anything else. In the proposed research project, my goal is to provide (in collaboration with M. Hashem Pesaran) new quantitative answers and fresh insights into some important yet unresolved issues in this area. Recent theoretical research on consumption has made it clear that a potentially major determinant of the time paths of consumption is how intertemporally optimising households insure themselves against future contingencies through precautionary savings. There has been little work on assessing this hypothesis using formal econometric techniques, however. The few existing studies using formal econometric techniques are not tightly integrated with the theory of households' optimal consumption decisions under precautionary savings. In the proposed research project, we intend to fill this gap.

This will allow us to provide empirically sound quantitative answers to the following types of questions:
- What are the effects of changes in labour income uncertainty on households' consumption and savings decisions? Are these effects sizeable enough to affect long-run economic performance?

- To what extent do price level expectations affect households' consumption and savings decisions?

- What is the impact on the time paths of consumption and savings of fiscal policies that smooth households' labour income fluctuations (but that may not affect their expected total lifetime resources)? Quantitative answers to these questions will substantially further our understanding of questions that have been at the core of recent macroeconomic research, and will undoubtedly stimulate further macroeconometric work in this area using the novel techniques to be developed and used in this project.

Training content (objective, benefit and expected impact)

The proposed research project will enable me to learn further out the econometrics of dynamic heterogeneous panels from M. Hashem Pesaran and his collaborators. As my research so far has addressed the macroeconomics of decision making under uncertainty and information heterogeneity mainly from a quantitative theory perspective, this would have an enormously positive impact on the empirical content and rigor of my future research projects going far beyond the important insights into consumption to be gained from the proposed research project.

Links with industry / industrial relevance (22)

Call for proposal

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University of Cambridge
EU contribution
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Sidgwick Avenue
CB3 9DE Cambridge
United Kingdom

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