Daney David Valdivia Coria

Notes on DSGE models

August - 2011

RULE OF THUMB CONSUMERS

Introduction of rule of thumb consumers change dramatically the response of
consumption to different shocks, in principle to monetary and fiscal shocks.
Non Ricardians households may alter the effects of monetary shocks.
R-O-T dont borrow, nor save in order to smooth their consumption, each period
they consume their current labor income.
Presence of rule of thumb can capture important aspects of actual economies
which are missing in conventional models.
Support of the presence for industrialized economies can be found in Campell
and Mankiw (1989) consumption, income and interest rates: reinterpreting the
times series evidence.
Not single representative household but by two groups:
Half of households are forward- looking and consume their permanent income,
reluctant to substitute consumption Intertemporal in response to interest rate
movements - Half Rule of thumb of consuming their current income.
The presence of rule of thumb consumers rejects the permanent income
hypothesis on the basic of aggregate data.
Rule of thumb implies important consequences for fiscal policy
Interpretations includes myopia, lack of access to capital markets, fear of
saving, ignorance of intertemporal trading opportunities.

Max E t t ( C0t , L0t )

0

N 0t + L0t =1
0
0
0
0
0
Pt C0t + Pt I 0t + R1
t Bt +1=W t N t +Z t K t +B t + t

Form the Lagranian and express the budget constraint in real terms.
Assume that optimizer have the following utility functions

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Daney David Valdivia Coria

Notes on DSGE models

August - 2011

Basic Neoclassical model of growth in business cycle

King Plosser and Rebelo

Production, growth and B
The basic neoclassic mo

FOC
Ktal. Supply
Endogenous labor supply, a SS requires that hours per personEuler
be invariant to the level of productivity
Marginal utility on consumption
Marginal utility of wealth

Marginal rate of substitution between leisure and consumptions

v()

Twice differentiable function and concave

G=1 The concavity requires

log ( v )

que sea creciente y convexa

With this utility function

Consumers must be willing to expand their consumption at a constant
rate when real interest rate is constant

Ct =C t +1

Optimal to supply a constant number of hours when the real interest rate
is constant and wage rate grows at a constant rate.

v()

Is concave if

v()

Is convex if

To ensure the

v ()

<1

>1
concavity:
2

v ( L ) v ' ' ( L ) > ( 12 ) [ v ' ( L ) ]

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Daney David Valdivia Coria

Notes on DSGE models

August - 2011

Find labor supply

Ktal supply

( (( ) ) )

d
Z
:1=E0 R1
t
d K t +1
P

d B0t +1

From

an

optimal

{C t }t =0 { K t }t=0 { N t }t=0 { K t }t=0

+1

t +1

C, L,N , K

K t lim t K t +1=0
t

Rule Of Thumb Consumers

U ( C r , Lr )
Pt CtR=W t N Rt

st.

But they can choose optimally the hours worked

Labor supply is = to optimizer

1
1 W
= R
R
Lt C t P

( )

In the case of the elasticity

is high =1

0,R
U ()=ln C 0,R
t + ln Lt

In the restring labor supply

N tR N Rt W
=
LRt C Rt P
LRt =1N Rt
1
Ex . N tR=
2

( ) C =( WP ) N
W 1
C =( )
P 2
t

R
t

R
t

R
t

follow

the

sequences

that satisfies the FOC condition and the

transversality requirement an

plans

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Daney David Valdivia Coria

Notes on DSGE models

August - 2011

Aggregation

Ct =( 1 ) C0t + C Rt
0

N t =( 1 ) N t + N t
Ct =( 1 ) C0t +

Ct =( 1 )

[( ) ]
W R
Nt
P

( WP ) L + [ ( WP ) N ]
0
t

R
t

Ct =( ( 1 ) ( 1N 0t ) + N Rt )

( WP )

Nt

(] WP )

Ct = ( 1 ) ( 1 ) N 0t +
N tR + ( 1 ) N t0( 1 ) N 0t

Ct = N t +12
( 1 ) N 0t

2 N t

(] WP )

1
0
N t =( 1 ) N t + 2
2
2 N t=2 N 0t ( 1 )+

Ct =( N t +12 N t )

Ct =( 1N t )

( WP )

( WP )
AS of labor

In general the AS doesnt change with the different types of agents

Consume there is no liquidity restrictions in the long run

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Daney David Valdivia Coria

Notes on DSGE models

August - 2011

C R C 0
= =1
C C
The effect is on aggregation of consumption

Ct = C Rt + (1 ) Ct0
( 1+ C
^ t )+ C
R ( 1+ C
^ tR ) + ( 1 ) C
0 ( 1+ C
^ 0t )
C
R R
0 0
^ t = C C
^ t + (1 ) C C
^
C
C
C t
^ t = C
^ Rt + (1 ) C
^ t0
C
But it change because of the Euler equation

^ 0t =Et ( C
^ t +1 )r^ t
C
^ 0t =C
^ 0t +1 r^ t +w Rt +1 E t ( C
^ t+ 1) C
^ t+1
C

^ t = C
^ Rt + (1 ) C
^ t0+1 (1 ) r^ t + C
^ tR+1 C
^ rt +1
C
^ t =( 1 ) C
^ 0t +1 + C
^ Rt ( 1 ) ^
^ tR+1 C
^ rt +1
C
Rt + C

^ t+ 1
C

^ t =C
^ t +1( 1 ) ^
^ tR+1 C
^ rt +1
C
Rt + C

CtR=

^
1 W
^ tR= W
C
2 P
P

( )

( )

(( ))

^
W
^ t =C
^ t +1( 1 ) ^
C
Rt +
P

t +1

^
Rt : Intertemporal effect

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Daney David Valdivia Coria

Notes on DSGE models

August - 2011

( WP )

t +1

: Credit restrictions

Not only consumption depends on interest rate, but also on the

intertemporal effect of

( WP )

Annex

U ( C , N )=

C 1 ( 1) v (N )
e
1

T.A.

g ( x ) =g ( x ) 1+

g ' ( x )
x ^x t
g ( x )

g ( x ) g ( x )=g '

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