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Permanent and Transitory Movements in Labor Income: An Explanation for "Excess Smoothness" in Consumption


  • Quah, Danny


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.

Suggested Citation

  • Quah, Danny, 1990. "Permanent and Transitory Movements in Labor Income: An Explanation for "Excess Smoothness" in Consumption," Journal of Political Economy, University of Chicago Press, vol. 98(3), pages 449-475, June.
  • Handle: RePEc:ucp:jpolec:v:98:y:1990:i:3:p:449-75

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    References listed on IDEAS

    1. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June.
    2. Dollar, David, 1986. "Technological Innovations, Capital Mobility, and the Product Cycle inNorth-South Trade," American Economic Review, American Economic Association, vol. 76(1), pages 177-190, March.
    3. Krugman, Paul R., 1979. "Increasing returns, monopolistic competition, and international trade," Journal of International Economics, Elsevier, vol. 9(4), pages 469-479, November.
    4. Feenstra, Robert C & Judd, Kenneth L, 1982. "Tariffs, Technology Transfer, and Welfare," Journal of Political Economy, University of Chicago Press, vol. 90(6), pages 1142-1165, December.
    5. Flam, Harry & Helpman, Elhanan, 1987. "Industrial policy under monopolistic competition," Journal of International Economics, Elsevier, vol. 22(1-2), pages 79-102, February.
    6. Helpman, Elhanan, 1984. "A Simple Theory of International Trade with Multinational Corporations," Journal of Political Economy, University of Chicago Press, vol. 92(3), pages 451-471, June.
    7. Judd, Kenneth L, 1985. "On the Performance of Patents," Econometrica, Econometric Society, vol. 53(3), pages 567-585, May.
    8. Richard Jensen & Marie Thursby, 1987. "A Decision Theoretic Model of Innovation, Technology Transfer, and Trade," Review of Economic Studies, Oxford University Press, vol. 54(4), pages 631-647.
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