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Permanent And Transitory Movements In Labor Income: An Explanation For "Excess Smoothness" In Consumption

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  • QUAH, D.

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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Bibliographic Info

Paper provided by Massachusetts Institute of Technology (MIT), Department of Economics in its series Working papers with number 535.

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Length: 43 pages
Date of creation: 1989
Date of revision:
Handle: RePEc:mit:worpap:535

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Web page: http://econ-www.mit.edu/
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Postal: MASSACHUSETTS INSTITUTE OF TECHNOLOGY (MIT), DEPARTMENT OF ECONOMICS, 50 MEMORIAL DRIVE CAMBRIDGE MASSACHUSETTS 02142 USA
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Keywords: labour market ; consumption ; income;

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