Robust Permanent Income in General Equilibrium

By Jun Nie, Senior Economist , Yulei Luo and Wei Li


  Download paper, RWP 15-14, October 2015

This paper provides a tractable continuous-time constant-absolute-risk averse (CARA)-Gaussian framework to quantitatively explore how the preference for robustness (RB) affects the interest rate, the dynamics of consumption and income, and the welfare costs of model uncertainty in general equilibrium. We show that RB significantly reduces the equilibrium interest rate, and reduces the relative volatility of consumption growth to income growth when the income process is stationary. Furthermore, we find that the welfare costs of model uncertainty are nontrivial for plausibly estimated income processes and calibrated RB parameter values. Finally, we extend the benchmark model to consider the separation of risk aversion and intertemporal substitution and regime-switching in income growth.

JEL Classification: C61, D81, E21

Article Citation

  • Nie, Jun,  Yasuo, Yulei Luo, Eric R. Young. 2015. “Robust Permanent Income in General Equilibrium,” Federal Reserve Bank of Kansas City, working paper no. 15-14, October. Available at https://doi.org/10.18651/RWP2015-14

Related Research

  • Luo, Yulei, Jun Nie, and Eric R. Young. 2012. “Robustness, information-processing constrains, and current account in small open economies,” Journal of International Economics, 88, 104-120. Available at http://doi.org/10.1016/j.jinteco.2012.02.004
  • Luo, Yulei, Jun Nie, and Eric R. Young. 2014. “Model uncertainty and intertemporal tax smoothing,” Journal of Economic Dynamics and Control, 45, 289-314. Available at http://doi.org/10.1016/j.jedc.2014.06.004
  • Wang, Neng. 2003. “Caballero meets Bewley: the permanent income hypothesis in general equilibrium,” American Economic Review, 93(3), 927-936. Available at http://doi.org/ 10.1257/000282803322157179

About the Author

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Jun Nie conducts research on unemployment and labor market policies, robustness and rational inattention, wealth inequality, and the Chinese economy. Read his bio.