"Rule-of-Thumb" Consumption, Intertemporal Substitution, and Risk Aversion

Abstract

This article reexamines evidence that some 50% of disposable income goes to households who simply consume their current incomes. Previous studies of such “rule-of-thumb” behavior have typically used log-linear Euler equations and have not distinguished between intertemporal substitution and relative risk aversion. In contrast, I use generalized method of moments to estimate the importance of rule-of-thumb behavior and separate intertemporal substitution from risk aversion by using the Epstein–Zin utility function. Using postwar U.S. data, I cannot reject the hypothesis that all income goes to permanent-income households—that is, that there are no rule-of-thumb households.

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