TEMPORAL RISK-AVERSION, INTERTEMPORAL SUBSTITUTION AND KEYNESIAN PROPENSITIES TO CONSUME

A two-period life-cycle model of precautionary saving is constructed in which the link between the coefficient of relative risk aversion and the inverse of the elasticity of intertemporal substitution is broken. There is excess sensitivity of consumption to unanticipated changes in future income. If there is temporal risk aversion, consumers with Ricardian rationality display Keynesian propensities to consume out of a tax cut. However, if there is temporal love for risk, rational consumers save less and consume more in response to a postponement of taxation.