Marginal propensity to consume

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08-12-2021
MAKRO

This note describes how the beta bersion of MAKRO is calibrated to provide empirically substantiated levels of private consumption by age. In addition, it is examined how households’ marginal propensity to consume (MPC) varies by age.

Abstract

This note describes how the beta bersion of MAKRO is calibrated to provide empirically substantiated levels of private consumption by age. In addition, it is examined how households’ marginal propensity to consume (MPC) varies by age. An important goal is to get a MPC that corresponds to Danish empirical results, both at the aggregate level, but also over the life cycle.

In MAKRO, private consumption is not determined by one representative agent, but instead by a series of cohorts via an overlapping generations (OLG) structure. The model thus takes into account the very large differences in wealth and consumption over the life cycle that are observed empirically. Each generation consists partly of forward-looking agents and partly of hand-to-mouth households (HtM).

In the work with MAKRO, we have included the financial part of the national accounts, so that there is full agreement between the overall model and the national accounts at a relatively detailed level. It has been assessed that empirically sound age profiles of household income, wealth, and private consumption are a central element in the empirical properties of MAKRO. Thus, the cohort structure of the model is fully exploited, e.g. when used to make a baseline forecast. In addition to ensuring that age profiles match the levels in the data it is also necessary that households in MAKRO have empirically reasonable marginal propensities to consume out of an income shock.

In conclusion:

  • The age profiles in MAKRO are calibrated so that the levels fit the data. As a first principle, this is done by calibrating age dependent discount factors so that the correct consumption profiles are obtained.
  • Due to the youngest and oldest age groups, it is not possible to fit the age profiles for consumption and wealth to the data via the discount rate alone if this is restricted to be positive. We solve this by including utility of wealth and bequests for the respective age groups.
  • To compare the MPC by age in MAKRO to the microeconometric literature, we construct a partial equilibrium version of MAKRO. The status of this work is that MAKRO - for the most central cohorts - is able to replicate the declining profile seen in Danish data.
  • The aggregate MPC in MAKRO depends greatly on the type and persistence of a shock. In the partial equilibrium model, first-year aggregate MPC ranges from 0.44 for a temporary income shock to 0.58 for a permanent income shock.