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The Insensitivity of Consumption to News About Income

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  • Kenneth D. West

Abstract

This paper uses a variance bounds test to see whether consumption is too sensitive to news about income to be consistent with a standard permanent income model, under the maintained hypothesis that income has a unit root. It is found that, if anything, consumption is less sensitive than the model would predict. This implication is robust to the representative consumer having private information about his future income that the econometrician does not have, to wealth shocks, and to transitory consumption. This suggests the importance in future research on the model of allowing for factors that tend to make consumption smooth.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2252.

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Date of creation: Sep 1988
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Handle: RePEc:nbr:nberwo:2252

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  1. Marjorie Flavin, 1985. "Excess Sensitivity of Consumption to Current Income: Liquidity Constraints or Myopia?," Canadian Journal of Economics, Canadian Economics Association, vol. 18(1), pages 117-36, February.
  2. Gregory Mankiw, N. & Shapiro, Matthew D., 1985. "Trends, random walks, and tests of the permanent income hypothesis," Journal of Monetary Economics, Elsevier, vol. 16(2), pages 165-174, September.
  3. Hansen, Lars Peter & Sargent, Thomas J., 1980. "Formulating and estimating dynamic linear rational expectations models," Journal of Economic Dynamics and Control, Elsevier, vol. 2(1), pages 7-46, May.
  4. Newey, Whitney K & West, Kenneth D, 1987. "A Simple, Positive Semi-definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix," Econometrica, Econometric Society, vol. 55(3), pages 703-08, May.
  5. Laurence J. Kotlikoff & Ariel Pakes, 1989. "Looking for the News in the Noise - Additional Stochastic Implications of Optimal Consumption Choice," NBER Working Papers 1492, National Bureau of Economic Research, Inc.
  6. Bernanke, Ben, 1985. "Adjustment costs, durables, and aggregate consumption," Journal of Monetary Economics, Elsevier, vol. 15(1), pages 41-68, January.
  7. 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.
  8. Christiano, Lawrence J & Eichenbaum, Martin & Marshall, David, 1991. "The Permanent Income Hypothesis Revisited," Econometrica, Econometric Society, vol. 59(2), pages 397-423, March.
  9. Lawrence J. Christiano & Martin S. Eichenbaum, 1986. "Temporal Aggregation and Structural Inference in Macroeconomics," NBER Technical Working Papers 0060, National Bureau of Economic Research, Inc.
  10. Lars Peter Hansen & Thomas J. Sargent, 1981. "Exact linear rational expectations models: specification and estimation," Staff Report 71, Federal Reserve Bank of Minneapolis.
  11. S. Grossman & R. Shiller, . "The Determinants of the Variability of Stock Market Price," Rodney L. White Center for Financial Research Working Papers 18-80, Wharton School Rodney L. White Center for Financial Research.
  12. Michener, Ron, 1984. "Permanent income in general equilibrium," Journal of Monetary Economics, Elsevier, vol. 13(3), pages 297-305, May.
  13. Hall, Robert E, 1978. "Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 971-87, December.
  14. Watson, Mark W., 1986. "Univariate detrending methods with stochastic trends," Journal of Monetary Economics, Elsevier, vol. 18(1), pages 49-75, July.
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