Isn’t it amazing how well the Consumption Euler Equation works?

While preparing graphs for my Principles of Macroeconomics class, I made this one:


The blue line is the growth rate of nominal consumption spending in the US, the red line is the nominal interest rate on a risk-free asset (a 10-year US government bond). See the way the red line tracks the blue line? That’s a beautiful confirmation of the Consumption Euler Equation which is the cornerstone of all modern macro models. (And no, I didn’t tweak this graph by restricting the time period or choosing different axes for the two lines or transforming the data somehow. This is a plot of the raw data without any editing. No funny stuff.)

PS: I’m actually not going to teach the Euler Equation in my Principles Class. Nobody seems to. Mankiw’s textbook doesn’t. But I’m increasingly asking myself why not?

Jonathan Swift on the Laffer Curve

But I will tell you a secret, which I learned many years ago from the commissioners of the customs in London; they said, when any commodity appeared to be taxed above a moderate rate, the consequence was, to lessen that branch of the revenue by one half; and one of those gentlemen pleasantly told me, that the mistake of parliaments, on such occasions, was owing to an errour of computing two and two to make four; whereas in the business of laying impositions, two and two never made more than one; which happens by lessening the import, and the strong temptation of running such goods as paid high duties, at least in this kingdom.

From An Answer to a Paper called a Memorial of the Poor Inhabitants, Tradesmen, and Labourers of Ireland, The Works of the Rev. Jonathan Swift, Volume 9

I found this reference in David Hume’s classic essay Of the Balance of Trade which is on the reading list of my International Economics class next Fall.