Household behaviour

Table of contents

Households consume a bundle of private goods (and services) and a bundle of public goods in each period. They supply labor to earn wages that they spend and invest.

G-Cubed models, treat households in line with approach described in Bryant and McKibbin (2001), which builds on the Blanchard (1985) Yaari (1965) approach, as extended by Faruqee, Laxton, and Symansky (1997) and Faruqee (2000b, 2000a).

Importantly, the treatment of households incorporates:

  • Blanchard’s assumption of a constant probability of death, implying that households are not infinitely lived but have a finite life expectancy; and
  • Yaari’s introduction of life insurance companies that permit agents to costlessly make annuities contracts contingent on their deaths.

Together, these features of the model facilitate derivation of an aggregate consumption function. This approach allows for the representation of life-cycle behaviors, where individuals save and consume based on expected lifetime resources without introducing the complexities associated with overlapping generations. Consumption is a linear function of human and non-human (financial) wealth. The marginal propensity to consume depends on both the constant probability of death and the rate of time preference.

Faruqee, Laxton, and Symansky (1997) extend the Blanchard-Yaari model in two key ways.

  1. They introduce a more detailed age-earning profile for individuals’ incomes that shows a rise with age and experience when individuals are relatively young but then eventually declining with age as individuals approach retirement years and beyond.
  2. They incorporate liquidity-constrained consumers to reflect capital-market imperfections that prevent some agents from borrowing against their future incomes.

Total labor income is distributed across different age cohorts according to fixed, age-specific weights derived from empirical observations. However, total labor income was independent of changes in the demographic composition of the population. Faruqee (2000b, 2000a) modifies this approach to instead construct labor income from the bottom up, based upon demographic information.

That treatment of demographics is central to the approach in G-Cubed as detailed in Bryant and McKibbin (2001).

References

Blanchard, Olivier J. (1985) “Debt, Deficits, and Finite Horizons.” Journal of Political Economy 93: pp. 223-47.

Bryant, Ralph C. and McKibbin, Warwick J. (2001) Incorporating Demographic Change in Multi-Country Macroeconomic Models: Some Preliminary Results, Draft working paper.

Hamid Faruqee & Douglas Laxton & Steven Symansky, (1997) “Government Debt, Life-Cycle Income, and Liquidity Constraints: Beyond Approximate Ricardian Equivalence,” IMF Staff Papers, Palgrave Macmillan, vol. 44(3), pages 374-382, September.

Faruqee, Hamid. (2000a) “Population Aging and its Macroeconomic Implications.” Chapter I in Japan: Selected Issues. IMF Staff Country Report No. 00/144. Washington, DC: International Monetary Fund, November 2000.

Faruqee, Hamid. (2000b) “Population Aging and its Macroeconomic Implications: A Framework for Analysis.” Draft manuscript. Washington, DC: International Monetary Fund, October 2000.

Yaari, Menahem E. (1965) “Uncertain Lifetime, Life Insurance, and the Theory of the Consumer.” Review of Economic Studies, Vol. 32 (April 1965), pp. 137-50.