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Household Production and the Excess Sensitivity of Consumption to Current Income

  • Urban J. Jermann
  • Marianne Baxter

Empirical research on the permanent-income hypothesis (PIH) has found that consumption growth is excessively sensitive to predictable changes in income. This finding is interpreted as strong evidence against the PIH. We propose an explanation for apparent excess sensitivity that is based on a quantitative equilibrium model of household production in which permanent-income consumers respond to shifts in sectoral wages and prices by substituting work effort and consumption across home and market sectors. Although the PIH is true, this mechanism generates apparent excess sensitivity because market consumption responds to predictable income growth.

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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/aer.89.4.902
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Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 89 (1999)
Issue (Month): 4 (September)
Pages: 902-920

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Handle: RePEc:aea:aecrev:v:89:y:1999:i:4:p:902-920
Note: DOI: 10.1257/aer.89.4.902
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