SEMINAR 31 January 2013: David Cashin, University of Michigan

Characterizing Intertemporal Substitution via Pre-announced VAT Increase: Evidence from Japan

Abstract

This study measures intertemporal substitution via a pre-announced increase in Japan’s VAT rate from three to five percent. Matching the time path of expenditures generated by a dynamic structural model of household consumption to empirical estimates of the intertemporal substitution response to the VAT increase, I find that expenditure is sensitive to a change in the future price level due to accelerated purchases of durables and stockpiling of storables. However, consumption is relatively insensitive. The intertemporal elasticity of substitution in consumption (IES) is 0.07, and is precisely estimated. Because the IES is small, the results suggest policies that alter the future price level will have a limited impact on the timing of household expenditure.

Keywords: Intertemporal substitution, consumption, fiscal policy, VAT

JEL Classification: D12 E21 E6 H24 H31