The Excess Smoothness of Consumption: Identification and Interpretation
AbstractThe paper investigates the implications of the omitted information problem -- that is, the econometric problem which arises because an econometrician cannot explicitly include the complete set of variables potentially used by agents -- in the context of the "excess smoothness" phenomenon posed by Deaton 11987]. The paper shows that an econometrician who fails to take into account the effects of omitted information will incorrectly conclude that an empirical finding of excess smoothness of consumption implies that the income process is nonstationary. By contrast, with a more thorough understanding of the omitted information problem, the finding of excess smoothness of consumption is easily explained with two assumptions: a) the consumption data is generated by the excess sensitivity alternative hypothesis, in which consumption is a weighted average of current income and permanent income, and b) agents are forecasting on the basis of a larger information set than the econometrician. Further, excess smoothness is revealed to be consistent with a wide range of stationary income processes as well as nonstationary income processes. Thus the common presumption that the excess smoothness phenomenon is linked in an essential way to the stationarity or nonstationarity of the income process evaporates when omitted information is taken into consideration.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2807.
Date of creation: Dec 1988
Date of revision:
Contact details of provider:
Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
Web page: http://www.nber.org
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Lawrence J. Christiano, 1987.
"Is consumption insufficiently sensitive to innovations in income?,"
106, Federal Reserve Bank of Minneapolis.
- Christiano, Lawrence J, 1987. "Is Consumption Insufficiently Sensitive to Innovations in Income?," American Economic Review, American Economic Association, vol. 77(2), pages 337-41, May.
- West, Kenneth D., 1988.
"The insensitivity of consumption to news about income,"
Journal of Monetary Economics,
Elsevier, vol. 21(1), pages 17-33, January.
- Kenneth D. West, 1988. "The Insensitivity of Consumption to News About Income," NBER Working Papers 2252, National Bureau of Economic Research, Inc.
- Christiano, Lawrence J & Eichenbaum, Martin & Marshall, David, 1991.
"The Permanent Income Hypothesis Revisited,"
Econometric Society, vol. 59(2), pages 397-423, March.
- Lawrence J. Christiano & Martin Eichenbaum & David Marshall, 1990. "The permanent income hypothesis revisited," Staff Report 129, Federal Reserve Bank of Minneapolis.
- Lawrence J. Christiano & Martin Eichenbaum & David Marshall, 1987. "The Permanent Income Hypothesis Revisited," NBER Working Papers 2209, National Bureau of Economic Research, Inc.
- Campbell, John & Mankiw, Gregory, 1987.
"Are Output Fluctuations Transitory?,"
3122545, Harvard University Department of Economics.
- Campbell, John Y. & Mankiw, N. Gregory, 1990.
"Permanent Income, Current Income, and Consumption,"
3353762, Harvard University Department of Economics.
- Nelson, Charles R. & Plosser, Charles I., 1982. "Trends and random walks in macroeconmic time series : Some evidence and implications," Journal of Monetary Economics, Elsevier, vol. 10(2), pages 139-162.
- 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.
- Hayashi, Fumio, 1982. "The Permanent Income Hypothesis: Estimation and Testing by Instrumental Variables," Journal of Political Economy, University of Chicago Press, vol. 90(5), pages 895-916, October.
- Lars Peter Hansen & Thomas J. Sargent, 1981. "Exact linear rational expectations models: specification and estimation," Staff Report 71, Federal Reserve Bank of Minneapolis.
- Campbell, John Y, 1987.
"Does Saving Anticipate Declining Labor Income? An Alternative Test of the Permanent Income Hypothesis,"
Econometric Society, vol. 55(6), pages 1249-73, November.
- John Y. Campbell, 1988. "Does Saving Anticipate Declining Labor Income? An Alternative Test of the Permanent Income Hypothesis," NBER Working Papers 1805, National Bureau of Economic Research, Inc.
- John Y. Campbell & N. Gregory Mankiw, 1989.
"Consumption, Income and Interest Rates: Reinterpreting the Time Series Evidence,"
in: NBER Macroeconomics Annual 1989, Volume 4, pages 185-246
National Bureau of Economic Research, Inc.
- John Y. Campbell & N. Gregory Mankiw, 1990. "Consumption, Income, and Interest Rates: Reinterpreting the Time Series Evidence," NBER Working Papers 2924, National Bureau of Economic Research, Inc.
- Stephen R. Blough, 1994. "Near common factors and confidence regions for present value models," Working Papers 94-3, Federal Reserve Bank of Boston.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().
If references are entirely missing, you can add them using this form.