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Household Production and the Excess Sensitivity of Consumption to Current Income

  • Marianne Baxter
  • Urban J. Jermann

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 version of Becker's (1965) 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.nber.org/papers/w7046.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7046.

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Date of creation: Mar 1999
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Publication status: published as American Economic Review, Vol. 89, no. 5 (September 1999): 902-920.
Handle: RePEc:nbr:nberwo:7046
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  1. Attanasio, O.P. & Browning, M.J., 1993. "Consumption over the life cycle and over the business cycle," Discussion Paper 1993-14, Tilburg University, Center for Economic Research.
  2. Campbell, John Y. & Mankiw, N. Gregory, 1990. "Permanent Income, Current Income, and Consumption," Scholarly Articles 3353762, Harvard University Department of Economics.
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  30. repec:fth:harver:1435 is not listed on IDEAS
  31. Campbell, John Y. & Mankiw, N. Gregory, 1991. "The response of consumption to income : A cross-country investigation," European Economic Review, Elsevier, vol. 35(4), pages 723-756, May.
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