Intertemporal elasticity of substitution with leisure margin

Abstract

This paper investigates households’ consumption smoothing behavior by estimating the intertemporal elasticity of substitution of consumption (IES) while allowing labor/leisure to vary. To this end, we adopt a utility specification that allows non-separability between consumption and leisure. Using this specification, we define a leisure margin as the gap between the IES that allows leisure to vary and the IES that keeps leisure constant. We find a positive and statistically significant leisure margin throughout the paper. In addition, the leisure margin becomes larger when the spouse’s leisure is taken into consideration. This result indicates that family labor supply plays an important role in households’ consumption decisions. We further explore the heterogeneous nature of nonmarket time, and show that consumption-leisure substitutability could be explained largely by home production. Our findings demonstrate the importance of time allocation when individuals make decisions on consumption and saving.