Working Paper: CEPR ID: DP1557
Authors: John Muellbauer
Abstract: This paper analyses and forecasts annual time series of aggregate real income per head in the United States. The approach integrates elements from recent univariate time-series analyses with multi-equation macromodels in which policy feedback rules have been endogenized. The main conclusions are as follows. First, aggregate real per capita income is subject to significant trend reversion. This conclusion comes through more clearly by examining the data at an annual rather than the more usual quarterly frequency, and by incorporating multivariate economic content in the income process. Second, there is significant evidence for the Lucas (1976) or Haavelmo (1944) critique: in the United States there appears to have been a shift in the structural macro-policy reaction function causing a corresponding shift in the reduced-form income forecasting equation. This is associated with increased concern in the late 1980s over the size of US budget deficits. Third, with the above proviso, useful real income forecasts can be made as far as three years ahead. Finally, the paper provides empirical evidence for the effectiveness of monetary policy on real output or income. The change in the short-term interest rate is highly significant in forecasting income growth up to three years after the change.
Keywords: income persistence; macropolicy feedback rules; structural breaks; lucas critique; monetary policy transmission; macro forecasts
JEL Codes: E32; E37; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| aggregate real per capita income (E25) | long-run average income (E25) |
| structural shift in macro policy reaction function (E60) | reduced-form income forecasting equation (C51) |
| changes in short-term interest rates (E43) | real income growth (O49) |
| changes in interest rates (E43) | consumer spending and investment decisions (E20) |