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Dynamic Factor Models of Consumption, Hours, and Income

  • Joseph G. Altonji
  • Ana Paula Martins
  • Aloysius Siow

This paper addresses two questions. First, what are the key factors that affect a consumer's lifetime budget constraint and how do they evolve over the lifecycle? Second, how do consumers respond to changes in these factors? We examine the permanent income hypothesis and the Keynesian consumption model using a dynamic factor model of consumption, hours, wages, unemployment, and income. We show that a quarterly dynamic factor model with restrictions on the lag structure nay be used with annual panel data to account for the fact that in many micro panel data sets the variables relevant to a study are measured at different time intervals and/or are aggregates for the calendar year. By using several income indicators we are able to extend the panel data studies of Hall and Mishkin and Bernanke to allow for measurement error. We are also able to study the response of income and consumption to some of the factors which determine them. In addition, we study a dynamic factor representation of a joint lifecycle model of consumption and labor supply. We provide estimates of the effect of wages, unemployment, and other income determinants on the marginal utility of income as well as estimates of the substitution effects of wage change on labor supply and consumption.

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File URL: http://www.nber.org/papers/w2155.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2155.

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Date of creation: Jan 1987
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Publication status: published as Altonji, Joseph G., Ana Paula Martins and Aloysius Siow. "Dynamic Factor Models Of Consumption, Hours And Income," Research in Economics, 2002, v56(1,Mar), 3-59.
Handle: RePEc:nbr:nberwo:2155
Note: LS
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  1. Joseph G. Altonji & Lewis M. Segal, 1994. "Small sample bias in GMM estimation of covariance structures," Working Paper Series, Macroeconomic Issues 94-8, Federal Reserve Bank of Chicago.
  2. Hayashi, Fumio, 1985. "The Permanent Income Hypothesis and Consumption Durability: Analysis Based on Japanese Panel Data," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1083-1113, November.
  3. K. Newey, Whitney, 1985. "Generalized method of moments specification testing," Journal of Econometrics, Elsevier, vol. 29(3), pages 229-256, September.
  4. Bernanke, Ben S, 1984. "Permanent Income, Liquidity, and Expenditure on Automobiles: Evidence from Panel Data," The Quarterly Journal of Economics, MIT Press, vol. 99(3), pages 587-614, August.
  5. Campbell, John Y & Deaton, Angus, 1989. "Why Is Consumption So Smooth?," Review of Economic Studies, Wiley Blackwell, vol. 56(3), pages 357-73, July.
  6. Joseph Altonji & Christina Paxson, 1985. "Job Characteristics and Hours of Work," Working Papers 578, Princeton University, Department of Economics, Industrial Relations Section..
  7. Baker, Michael, 1997. "Growth-Rate Heterogeneity and the Covariance Structure of Life-Cycle Earnings," Journal of Labor Economics, University of Chicago Press, vol. 15(2), pages 338-75, April.
  8. Chowdhury, Gopa & Nickell, Stephen, 1985. "Hourly Earnings in the United States: Another Look at Unionization, Schooling, Sickness, and Unemployment Using PSID Data," Journal of Labor Economics, University of Chicago Press, vol. 3(1), pages 38-69, January.
  9. Hause, John C, 1980. "The Fine Structure of Earnings and the On-the-Job Training Hypothesis," Econometrica, Econometric Society, vol. 48(4), pages 1013-29, May.
  10. Hall, Robert E & Mishkin, Frederic S, 1982. "The Sensitivity of Consumption to Transitory Income: Estimates from Panel Data on Households," Econometrica, Econometric Society, vol. 50(2), pages 461-81, March.
  11. Gruber, Jonathan, 1997. "The Consumption Smoothing Benefits of Unemployment Insurance," American Economic Review, American Economic Association, vol. 87(1), pages 192-205, March.
  12. Chamberlain, Gary, 1984. "Panel data," Handbook of Econometrics, in: Z. Griliches† & M. D. Intriligator (ed.), Handbook of Econometrics, edition 1, volume 2, chapter 22, pages 1247-1318 Elsevier.
  13. Zeldes, Stephen P, 1989. "Consumption and Liquidity Constraints: An Empirical Investigation," Journal of Political Economy, University of Chicago Press, vol. 97(2), pages 305-46, April.
  14. MaCurdy, Thomas E., 1982. "The use of time series processes to model the error structure of earnings in a longitudinal data analysis," Journal of Econometrics, Elsevier, vol. 18(1), pages 83-114, January.
  15. 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.
  16. Hall, Robert E, 1978. "Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 971-87, December.
  17. Martin Browning & Annamaria Lusardi, 1995. "Household Saving: Micro Theories and Micro Facts," Department of Economics Working Papers 1995-02, McMaster University.
  18. Attfield, Clifford L F & Browning, Martin J, 1985. "A Differential Demand System, Rational Expectations and the Life Cycle Hypothesis," Econometrica, Econometric Society, vol. 53(1), pages 31-48, January.
  19. Holbrook, Robert & Stafford, Frank P, 1971. "The Propensity to Consume Separate Types of Income: A Generalized Permanent Income Hypothesis," Econometrica, Econometric Society, vol. 39(1), pages 1-21, January.
  20. Heckman, James J & Macurdy, Thomas E, 1980. "A Life Cycle Model of Female Labour Supply," Review of Economic Studies, Wiley Blackwell, vol. 47(1), pages 47-74, January.
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