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Permanent and Transitory Movements in Labor Income: An Explanation for "Excess Smoothness" in Consumption

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Quah, Danny

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Abstract

Many have argued that, if labor income is difference stationary, the permanent income hypothesis predicts that consumption should be relatively volatile. In U.S. aggregate data, labor income is well characterized as having a unit root; however, consumption turns out to be relatively smooth. This anomaly is known as Deaton's paradox. The author resolves this paradox by providing decompositions of labor income into permanent and transitory components. They preserve the univariate dynamic properties of labor income. However, when agents distinguish permanent and transitory movements in their labor income, the permanent income hypothesis correctly predicts the observed smoothness in consumption. Copyright 1990 by University of Chicago Press.

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Publisher Info
Article provided by University of Chicago Press in its journal Journal of Political Economy.

Volume (Year): 98 (1990)
Issue (Month): 3 (June)
Pages: 449-75
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Handle: RePEc:ucp:jpolec:v:98:y:1990:i:3:p:449-75

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  1. Ramsey, J.B. & Lampart, C., 1997. "The Decomposition of Economic Relationships by Time Scale Using Wavelets," Working Papers 97-08, C.V. Starr Center for Applied Economics, New York University. [Downloadable!]
  2. Takashi Kano, 2003. "A Structural VAR Approach to the Intertemporal Model of the Current Account," Working Papers 03-42, Bank of Canada. [Downloadable!]
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  3. Mario Padula, 2000. "Excess Smoothness and Durable Goods: Evidence from Subjective Expectations Data," CSEF Working Papers 38, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy. [Downloadable!]
  4. Katsunori Watanabe & Takayuki Watanabe & Tsutomu Watanabe, 1999. "Tax Policy and Consumer Spending: Evidence from Japanese Fiscal Experiments," NBER Working Papers 7252, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  5. Daniela Federici & Giancarlo Gandolfo, 2001. "Endogenous Growth in an Open Economy and the Real Exchange Rate," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
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  6. Giorgio Primiceri & Thijs van Rens, 2002. "Inequality over the Business Cycle: Estimating Income Risk Using Micro-Data on Consumption," Economics Working Papers 943, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 2004. [Downloadable!]
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  7. Danny Quah, 1991. "The Relative Importance of Permanent and Transitory Components: Identi- fication and Some Theoretical Bounds," NBER Technical Working Papers 0106, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. Jim Malley & Hassan Molana, 1997. "The Permanent Income Hypothesis Revisited. Reconciling Evidence from Aggregate Data with the Representative Consumer Behaviour," Working Papers 9708, Department of Economics, University of Glasgow. [Downloadable!]
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  9. Mario J. Crucini, 2006. "International Real Business Cycles," Working Papers 0617, Department of Economics, Vanderbilt University. [Downloadable!]
  10. Mario Forni & Luca Gambetti, 2008. "The dynamic e ects of monetary policy: A structural factor model approach," Center for Economic Research (RECent) 026, University of Modena and Reggio E., Dept. of Economics. [Downloadable!]
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  11. Jim Malley & Hassan Molana, 2002. "The Life-Cycle-Permanent-Income Model: A Reinterpretation and Supporting Evidence," Working Papers 2002_17, Department of Economics, University of Glasgow. [Downloadable!]
  12. Forni, Mario & Lippi, Marco & Reichlin, Lucrezia, 2003. "Opening the Black Box: Structural Factor Models versus Structural VARs," CEPR Discussion Papers 4133, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  13. Donaghy, Kieran & Federici, Daniela & Wymer, Clifford R., 1999. "An Empirical Two-Good Two-Country Representative- Agent Model with Endogenous Growth," ERSA conference papers ersa99pa347, European Regional Science Association. [Downloadable!]
  14. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2004. "A Critique of Structural VARs Using Real Business Cycle Theory," Levine's Bibliography 122247000000000518, UCLA Department of Economics. [Downloadable!]
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  15. Elif C. Arbatli, 2008. "Futures Markets, Oil Prices and the Intertemporal Approach to the Current Account," Working Papers 08-48, Bank of Canada. [Downloadable!]
  16. Lawrence J. Christiano & Jonas Fisher, 1995. "Tobin's q and Asset Returns: Implications for Business Cycle Analysis," NBER Working Papers 5292, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  17. Liam Graham & Stephen Wright, 2006. "Inspecting the noisy mechanism: the stochastic growth model with partial information," Computing in Economics and Finance 2006 207, Society for Computational Economics. [Downloadable!]
  18. Emilio Fernandez-Corugedo & Simon Price & Andrew Blake, . "The dynamics of consumers' expenditure: the UK consumption ECM redux," Bank of England working papers 204, Bank of England. [Downloadable!]
  19. Joseph G. Haubrich, 1990. "Consumption and fractional differencing: old and new anomalies," Working Paper 9010, Federal Reserve Bank of Cleveland. [Downloadable!]
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  20. John Shea, 1998. "What Do Technology Shocks Do?," NBER Working Papers 6632, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  21. Laura Serlenga, . "Three Alternative Approaches to Test the Permanent Income Hypothesis in Dynamic Panels," series 0005, Dipartimento di Scienze Economiche - Università di Bari. [Downloadable!]
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