Elasticity of Intertemporal Substitution: An Investigation in Iran

We present estimates of the Elasticity of Intertemporal Substitution (EIS) for Iranian households using synthetic cohort panels based on household micro-data. Results show significant difference with the common values used in Dynamic Stochastic General Equilibrium (DSGE) models which are originally based on estimated values for developed countries. We show that this difference has important theoretical and practical implications. In a simple Real Business Cylce (RBC) setting using the estimated values rather than the common values will help explain 33% more of consumption volatility. We also study the role of EIS in the consumption response to a monetary shock in a Smets Wouters (2003) model as a benchmark for New-Keynesian monetary models. Results indicate that the monetary policy shock has less impact on consumption in a country with lower elasticity of intertemporal substitution.