Mankiw's Puzzle on Consumer Durables as a MisspecificationTam Bang Vu, University of Hawaii at Manoa Abstract Mankiw (1982) shows theoretically that consumer durable expenditure follows a linear ARMA(1,1) process, but the data analyzed supports an AR(1) instead, thus, a puzzle. In this paper, unlike Mankiw, the error term is specified as multiplicative. Additionally, the interest rate and depreciation rate are allowed to change over time. As a result, the consumer durable expenditure appears to follow a nonlinear ARMA(1,1) process in logarithm, where the moving average part is relevant in a nonlinear way. This implies that the standard linear model is a misspecification. A historical data analysis and a Monte-Carlo study support the nonlinear ARMA(1,1) model. Reflection on nondurable and service expenditure is provided as a special case of the durable expenditure when the depreciation rate is one. Keywords: Stochastic consumption, time varying depreciation rate, multiplicative error, nonlinear ARMA process. |