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

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

fredgraph

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?

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