Working Paper: NBER ID: w2155
Authors: Joseph G. Altonji; Ana Paula Martins; Aloysius Siow
Abstract: This paper addresses two questions. First, what are the key factors that affect a consumer's lifetime budget constraint and how do they evolve over the lifecycle? Second, how do consumers respond to changes in these factors? We examine the permanent income hypothesis and the Keynesian consumption model using a dynamic factor model of consumption, hours, wages, unemployment, and income. We show that a quarterly dynamic factor model with restrictions on the lag structure nay be used with annual panel data to account for the fact that in many micro panel data sets the variables relevant to a study are measured at different time intervals and/or are aggregates for the calendar year. By using several income indicators we are able to extend the panel data studies of Hall and Mishkin and Bernanke to allow for measurement error. We are also able to study the response of income and consumption to some of the factors which determine them. In addition, we study a dynamic factor representation of a joint lifecycle model of consumption and labor supply. We provide estimates of the effect of wages, unemployment, and other income determinants on the marginal utility of income as well as estimates of the substitution effects of wage change on labor supply and consumption.
Keywords: Consumption; Labor Supply; Dynamic Factor Models; Permanent Income Hypothesis; Keynesian Consumption Model
JEL Codes: D91; E21; J22
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| wages (J31) | marginal utility of income (D11) |
| unemployment (J64) | marginal utility of income (D11) |
| income determinants (E25) | marginal utility of income (D11) |
| changes in income (E25) | consumption (E21) |
| labor supply (J20) | consumption (E21) |
| lagged unemployment (J64) | changes in consumption (D12) |
| lagged income factors (E25) | changes in consumption (D12) |
| measurement error in income (D31) | variance in family income changes (D31) |
| innovations in wage (J31) | variance in family income changes (D31) |
| innovations in unemployment (J65) | variance in family income changes (D31) |
| innovations in work hours (J22) | variance in family income changes (D31) |
| Keynesian model (E12) | consumer behavior (D19) |
| permanent income hypothesis (D15) | consumer behavior (D19) |