Working Paper: NBER ID: w7046
Authors: Marianne Baxter; Urban J. Jermann
Abstract: Empirical research on the permanent income hypothesis (PIH) has found that consumption growth is excessively sensitive to predictable changes in income. This finding is interpreted as strong evidence against the PIH. We propose an explanation for apparent excess sensitivity that is based on a quantitative equilibrium version of Becker's (1965) model of household production in which permanent income consumers respond to shifts in sectoral wages and prices by substituting work effort and consumption across home and market sectors. Although the PIH is true, this mechanism generates apparent excess sensitivity because market consumption responds to predictable income growth.
Keywords: Permanent Income Hypothesis; Household Production; Consumption Sensitivity
JEL Codes: D13; E21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| market wages (J31) | market consumption (F61) |
| predictable income changes (E25) | market consumption (F61) |
| household production dynamics (D13) | excess sensitivity of consumption to predictable income changes (D11) |
| market consumption (F61) | predictable income growth (E25) |
| market consumption growth (F62) | predictable income growth (E25) |