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Consumption, Income, and Interest Rates: Reinterpreting the Time Series Evidence

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  • John Y. Campbell
  • N. Gregory Mankiw

Abstract

This paper proposes that the time-series data on consumption, income, and interest rates are best viewed as generated not by a single representative consumer but by two groups of consumers. Half the consumers are forward-looking and consume their permanent income, but are extremely reluctant to substitute consumption temporarily. Half the consumers follow the "rule of thumb" of consuming their current income. The paper documents three empirical regularities that, it argues, are best explained by this medal. First, expected changes in income are associated with expected changes in consumption. Second, expected real interest rates are not associated with expected changes in consumption. Third, periods in which consumption is high relative to income are typically followed by high growth in income. The paper concludes by briefly discussing the implications of these findings for economic policy and economic research.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2924.

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Date of creation: Apr 1989
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Publication status: published as Blanchard, Olivier Jean and Stanley Fischer (eds.) NBER Macroeconomics Annual 1989, Volume 4. Cambridge, MA: MIT Press, 1989.
Handle: RePEc:nbr:nberwo:2924

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  1. Mankiw, N Gregory & Shapiro, Matthew D, 1986. "Risk and Return: Consumption Beta versus Market Beta," The Review of Economics and Statistics, MIT Press, vol. 68(3), pages 452-59, August.
  2. Kenneth D. West, 1987. "The Insensitivity of Consumption to News About Income," NBER Working Papers 2252, National Bureau of Economic Research, Inc.
  3. Ben S. Bernanke, 1982. "Adjustment Costs, Durables, and Aggregate Consumption," NBER Working Papers 1038, National Bureau of Economic Research, Inc.
  4. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Publishing House "SINERGIA PRESS", Publishing House "SINERGIA PRESS", vol. 33(1), pages 125-132.
  5. Matthew D. Shapiro & N. Gregory Mankiw, 1984. "Trends, Random Walks, and Tests of the Permanent Income Hypothesis," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 725, Cowles Foundation for Research in Economics, Yale University.
  6. Summers, Lawrence H, 1981. "Capital Taxation and Accumulation in a Life Cycle Growth Model," American Economic Review, American Economic Association, American Economic Association, vol. 71(4), pages 533-44, September.
  7. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 1(1), pages 19-46, January.
  8. Sanford J. Grossman & Robert J. Shiller, 1980. "The Determinants of the Variability of Stock Market Prices," NBER Working Papers 0564, National Bureau of Economic Research, Inc.
  9. Campbell, John Y. & Mankiw, N. Gregory, 1990. "Permanent Income, Current Income, and Consumption," Scholarly Articles 3353762, Harvard University Department of Economics.
  10. Alberto Giovannini & Philippe Weil, 1989. "Risk Aversion and Intertemporal Substitution in the Capital Asset Pricing Model," NBER Working Papers 2824, National Bureau of Economic Research, Inc.
  11. Evans, Paul, 1988. "Are Consumers Ricardian? Evidence for the United States," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 96(5), pages 983-1004, October.
  12. R. C. Merton, 1970. "Optimum Consumption and Portfolio Rules in a Continuous-time Model," Working papers, Massachusetts Institute of Technology (MIT), Department of Economics 58, Massachusetts Institute of Technology (MIT), Department of Economics.
  13. Michener, Ron, 1984. "Permanent income in general equilibrium," Journal of Monetary Economics, Elsevier, Elsevier, vol. 13(3), pages 297-305, May.
  14. Wilcox, David W, 1989. "Social Security Benefits, Consumption Expenditure, and the Life Cycle Hypothesis," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 97(2), pages 288-304, April.
  15. Koenig, Evan F, 1990. "Real Money Balances and the Timing of Consumption: An Empirical Investigation," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 105(2), pages 399-425, May.
  16. Hansen, Lars Peter & Singleton, Kenneth J, 1983. "Stochastic Consumption, Risk Aversion, and the Temporal Behavior of Asset Returns," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 91(2), pages 249-65, April.
  17. Mankiw, N. Gregory, 1981. "The permanent income hypothesis and the real interest rate," Economics Letters, Elsevier, Elsevier, vol. 7(4), pages 307-311.
  18. Hall, Robert E, 1978. "Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 86(6), pages 971-87, December.
  19. Olivier J. Blanchard, 1984. "Debt, Deficits and Finite Horizons," NBER Working Papers 1389, National Bureau of Economic Research, Inc.
  20. Jappelli, Tullio & Pagano, Marco, 1988. "Consumption and Capital Market Imperfection: An International Comparison," CEPR Discussion Papers, C.E.P.R. Discussion Papers 244, C.E.P.R. Discussion Papers.
  21. Marjorie A. Flavin, 1988. "The Excess Smoothness of Consumption: Identification and Interpretation," NBER Working Papers 2807, National Bureau of Economic Research, Inc.
  22. Hall, Robert E, 1988. "Intertemporal Substitution in Consumption," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 96(2), pages 339-57, April.
  23. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  24. Flavin, Marjorie A, 1981. "The Adjustment of Consumption to Changing Expectations about Future Income," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 89(5), pages 974-1009, October.
  25. Hayashi, Fumio, 1982. "The Permanent Income Hypothesis: Estimation and Testing by Instrumental Variables," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 90(5), pages 895-916, October.
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