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Revisiting the Empirical Inconsistency of the Permanent Income Hypothesis: Evidence from Rural China

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  • Liping Gao
  • Hyeongwoo Kim
  • Yaoqi Zhang

Abstract

Chow (1985) reports strong evidence in favor of the permanent income hypothesis (PIH) using observations from 1953 to 1982 in China. We revisit this issue with rural area household data in China during the post economic reform regime (1978-2009) as well as the postwar US data for comparison. Our in-sample analysis provides strong evidence against the PIH for both countries. Out-of-sample forecast exercises also reveal that consumption changes are highly predictable. Our vector autoregressive (VAR) model analysis also shows significantly positive responses of consumption to income shocks, and non-negligible proportions of variations in consumption are explained by innovations in income.

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Paper provided by Department of Economics, Auburn University in its series Auburn Economics Working Paper Series with number auwp2013-05.

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Date of creation: Mar 2013
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Handle: RePEc:abn:wpaper:auwp2013-05

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Keywords: Permanent Income Hypothesis; Consumption; Generalized Method of Moments; Diebold-Mariano-West Statistic; Vector Autoregressive;

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  1. Kim, Chulsoo, 1996. "Measuring Deviations from the Permanent Income Hypothesis," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 37(1), pages 205-25, February.
  2. Dejuan, Joseph P & Seater, John J & Wirjanto, Tony S, 2004. "A Direct Test of the Permanent Income Hypothesis with an Application to the U.S. States," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(6), pages 1091-1103, December.
  3. Christopher D. Carroll & Jiri Slacalek & Martin Sommer, 2011. "International Evidence on Sticky Consumption Growth," The Review of Economics and Statistics, MIT Press, vol. 93(4), pages 1135-1145, November.
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  14. Sommer Martin, 2007. "Habit Formation and Aggregate Consumption Dynamics," The B.E. Journal of Macroeconomics, De Gruyter, vol. 7(1), pages 1-25, August.
  15. Charles R. Nelson, 1985. "A Reappraisal of Recent Tests of the Permanent Income Hypothesis," NBER Working Papers 1687, National Bureau of Economic Research, Inc.
  16. Flavin, Marjorie A, 1981. "The Adjustment of Consumption to Changing Expectations about Future Income," Journal of Political Economy, University of Chicago Press, vol. 89(5), pages 974-1009, October.
  17. Ermini, Luigi, 1993. "Effects of Transitory Consumption and Temporal Aggregation on the Permanent Income Hypothesis," The Review of Economics and Statistics, MIT Press, vol. 75(4), pages 736-40, November.
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  19. Darby, Michael R, 1974. "The Permanent Income Theory of Consumption-A Restatement," The Quarterly Journal of Economics, MIT Press, vol. 88(2), pages 228-50, May.
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