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Pitfall of simple permanent income hypothesis model

Author

Listed:
  • Kazuto Masuda

    (Bank of Japan)

Abstract

Permanent Income Hypothesis (hereafter, PIH) is one of the central concepts in macroeconomics. Single equation version of PIH is often appeared in textbooks and academic papers. But, even in single equation version of PIH Romer(2006) suggested, to get economic insights from estimation, we need to consider the additional income determination equation and then we can't ignore “Simultaneous equations bias.” In this note, we examine this “Simultaneous equations bias” effect theoretically and empirically. Our results suggest that ignoring this bias will lead to the wrong estimates and conclusion. More attention should be given on simultaneous equations approach.

Suggested Citation

  • Kazuto Masuda, 2011. "Pitfall of simple permanent income hypothesis model," Economics Bulletin, AccessEcon, vol. 31(1), pages 35-40.
    • Handle: RePEc:ebl:ecbull:eb-10-00552
    as

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    References listed on IDEAS

    as
    1. Campbell, John Y. & Mankiw, N. Gregory, 1991. "The response of consumption to income : A cross-country investigation," European Economic Review, Elsevier, vol. 35(4), pages 723-756, May.
    2. Joseph P. Dejuan & John J. Seater, 2006. "A Simple Test of Friedman's Permanent Income Hypothesis," Economica, London School of Economics and Political Science, vol. 73(289), pages 27-46, February.
    3. Milton Friedman, 1957. "A Theory of the Consumption Function," NBER Books, National Bureau of Economic Research, Inc, number frie57-1, March.
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    More about this item

    Keywords

    Consumption; Instrumental variable; OLS; Permanent income hypothesis; Simultaneous equations bias;
    All these keywords.

    JEL classification:

    • E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment
    • C3 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables

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