The Permanent Income Hypothesis Revisited

Abstract:     
This paper investigates whether there are simple versions of the permanent income hypothesis which are consistent with the aggregate U.S. consumption and output data. Our analysis is conducted within the confines of a simple dynamic general equilibrium model of aggregate real output, investment, hours of work and consumption. We study the quantitative importance of two perturbations to the version of our model which predicts that observed consumption follows a random walk: (i) changing the production technology specification which rationalizes the random walk result, and (ii) replacing the assumption that agents' decision intervals coincide with the data sampling interval with the assumption that agents make decisions on a continuous time basis. We find substantially less evidence against the continuous time models than against their discrete time counterparts. In fact neither of the two continuous time models can be rejected at conventional significance levels. The continuous time models outperform their discrete time counterparts primarily because they explicitly account for the fact that the data used to test the models are tine averaged measures of the underlying unobserved point-in-time variables. The net result is that they are better able to accommodate the degree of serial correlation present in the first difference of observed per capita U.S. consumption.

Number of Pages in PDF File: 66

working papers series