Working Paper: NBER ID: w1805
Authors: John Y. Campbell
Abstract: The permanent income hypothesis implies that people save because they rationally expect their labor income to decline; they save "for a rainy day". It follows that saving should be at least as good a predictor of declines in labor income as any other forecast that can be constructed from publicly available information.The paper tests this hitherto ignored implication of the permanent income hypothesis, using quarterly aggregate data for the period 1953-84 in the U.S. A vector autoregression for saving and changes in labor income is used to generate an unrestricted forecast of declines in labor income. In the VAR, saving Granger causes labor income changes as one would expect if the PIH is true. The mean of the unrestricted forecast is far from the mean of saving, but the dynamics of the two series are quite similar.The paper presents both formal test statistics and an informal evaluation of the "fit" of the permanent income hypothesis. By contrast with most of the recent literature, the results here are valid when income is nonstationary.
Keywords: Permanent Income Hypothesis; Saving; Labor Income; Vector Autoregression; Economic Fluctuations
JEL Codes: D91; E21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| saving (E21) | labor income changes (J39) |