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Title: Complementarity, Income, and Substitution: A U(C,N) Utility for Macro

Author(s): Florin Ovidiu Bilbiie

Publication Date: March 2018

Keyword(s): business-cycle co-movement, consumption-hours complementarity, elasticity of intertemporal substitution, Fiscal multipliers, income and wealth effects and news shocks

Programme Area(s): Monetary Economics and Fluctuations

Abstract: In business-cycle, macro models the elasticity of intertemporal substitution (EIS) governs the economy's response to demand shocks and policy changes ("multipliers"). With general non-separable preferences, the EIS is determined by consumption-hours complementarity and the income effect on hours. Complementarity helps generate business-cycle co-movement following demand shocks, fiscal multipliers, and allows reconciling low EIS with low income-wealth effects. Yet existing utility functions restrict either complementarity, or income effects---or both---and artificially imply that EIS is exclusively a function of either. I propose a novel utility function where both complementarity and the income effect are arbitrary and can be calibrated separately.

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Bibliographic Reference

Bilbiie, F. 2018. 'Complementarity, Income, and Substitution: A U(C,N) Utility for Macro'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=12812