Working Paper: NBER ID: w2252
Authors: Kenneth D. West
Abstract: This paper uses a variance bounds test to see whether consumption is too sensitive to news about income to be consistent with a standard permanent income model, under the maintained hypothesis that income has a unit root. It is found that, if anything, consumption is less sensitive than the model would predict. This implication is robust to the representative consumer having private information about his future income that the econometrician does not have, to wealth shocks, and to transitory consumption. This suggests the importance in future research on the model of allowing for factors that tend to make consumption smooth.
Keywords: Consumption; Permanent Income Model; Income News
JEL Codes: E21; E32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| news about income (E25) | consumption (E21) |
| income (E25) | consumption (E21) |
| consumption variance < income variance (D11) | consumption is smoother than expected (E21) |
| consumption insensitivity to income news (D12) | characteristic of consumption behavior (D12) |