Marginal Propensity to Consume with Economic Shocks - FIML Markov-Switching Model Analysis

Abstract

Hamilton's Markov-switching model [5] was extended to the simultaneous equations model. A framework||for an instrumental variable interpretation of full information maximum likelihood (FIML) by Hausman [4] can be||used to deal with the problem of simultaneous equations based on the Hamilton filter [5]. A comparison of the||proposed FIML Markov-switching model with the LIML Markov-switching models [1,2,3] revealed the LIML||Markov-switching models to be a special case of the proposed FIML Markov-switching model, where all but the first||equation were just identified. Moreover, the proposed Markov-switching model is a general form in simultaneous||equations and covers a broad class of models that could not be handled previously. Excess sensitivity of marginal||propensity to consume with big shocks, such as housing bubble bursts in 2008, can be determined by applying the||proposed model to Campbell and Mankiw's consumption function [6], and allowing for the possibility of structural||breaks in the sensitivity of consumption growth to income growth.