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Liquidity Constraints and the Permanent Income Hypothesis: Pseudo Panel Estimation with German Consumption Survey Data

  • Martin Beznoska
  • Richard Ochmann

This paper empirically investigates the relevance of liquidity constraints and excess sensitivity in intertemporal household consumption. Using a pseudo panel that has been constructed on rich German consumption survey data, we estimate the consumption responses to permanent and transitory income shocks, as well as the presence of excess sensitivity to anticipated income changes. A switching regression approach with unknown sample separation is applied to identify the two regimes whether to be liquidity constrained or not. The results are used to test whether liquidity constraints affect the validity of the permanent income hypothesis. For households in the constrained regime, reactions to changes in transitory income are found to be significantly greater than for households in the unconstrained regime. Furthermore, we provide evidence for excess sensitivity to anticipated income changes for households in the constrained regime if total consumption, durable as well as non-durable, is considered.

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File URL: http://www.diw.de/documents/publikationen/73/diw_01.c.406513.de/dp1231.pdf
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Paper provided by DIW Berlin, German Institute for Economic Research in its series Discussion Papers of DIW Berlin with number 1231.

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Length: 34 p.
Date of creation: 2012
Date of revision:
Handle: RePEc:diw:diwwpp:dp1231
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  1. Greg Kaplan & Giovanni L. Violante, 2009. "How Much Consumption Insurance Beyond Self-Insurance?," NBER Working Papers 15553, National Bureau of Economic Research, Inc.
  2. Milton Friedman, 1957. "A Theory of the Consumption Function," NBER Books, National Bureau of Economic Research, Inc, number frie57-1, September.
  3. Richard Blundell & Luigi Pistaferri & Ian Preston, 2004. "Consumption inequality and partial insurance," IFS Working Papers W04/28, Institute for Fiscal Studies.
  4. Tullio Jappelli & Jörn-Steffen Pischke & Nicholas S. Souleles, 1998. "Testing For Liquidity Constraints In Euler Equations With Complementary Data Sources," The Review of Economics and Statistics, MIT Press, vol. 80(2), pages 251-262, May.
  5. Milton Friedman, 1957. "Introduction to "A Theory of the Consumption Function"," NBER Chapters, in: A Theory of the Consumption Function, pages 1-6 National Bureau of Economic Research, Inc.
  6. Orazio Attanasio & Nicola Pavoni, 2007. "Risk Sharing in Private Information Models with Asset Accumulation: Explaining the Excess Smoothness of Consumption," NBER Working Papers 12994, National Bureau of Economic Research, Inc.
  7. Randal Verbrugge & Thesia I. Garner, 2009. "Reconciling User Costs and Rental Equivalence: Evidence from the U.S. Consumer Expenditure Survey," Working Papers 427, U.S. Bureau of Labor Statistics.
  8. Lusardi, Annamaria, 1997. "Precautionary saving and subjective earnings variance," Economics Letters, Elsevier, vol. 57(3), pages 319-326, December.
  9. Tullio Jappelli & Luigi Pistaferri, 2010. "The Consumption Response to Income Changes," NBER Working Papers 15739, National Bureau of Economic Research, Inc.
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