Rule-Of-Thumb Households In The Czech Republic

Most modern macroeconomic models assume that households smooth consumption over their lifetime. However, there is substantial evidence that a sizable fraction of households faces liquidity constraints, thus the assumption of consumption smoothing is not met. This might be one of the reasons why the predictions of some models fail, for example those concerning effects of fiscal policy on consumption. To overcome this problem, some models assume that only a part of households (Ricardian households) smooth their consumption and the other part (rule-of-thumb households) consume their whole current disposable income. This paper estimates the fraction of rule-of-thumb households in the Czech Republic, based on the modified Euler equation using instrumental variables (approach by Campbell and Mankiw [4]). Furthermore, potential time variation in this parameter is investigated using the two-step strategy proposed by Kim [10] that deals with the endogeneity problem. Our results suggest that the share of rule-of-thumb consumers exceeds 40%. In addition, this share is unstable over time, however the decline in the recent years is puzzling and worth exploring further.