Habit Persistence, Non-Separability between Consumption and Leisure, or Rule-of-Thumb Consumers: Which Accounts for the Predictability of Consumption Growth?

Abstract

Consumption growth is predictable, a basic violation of the permanent-income hypothesis. This paper examines three possible explanations: rule-of-thumb behavior, in which households allow consumption to track per-period income flows rather than permanent income; habit persistence; and non-separability in preferences over consumption and leisure. The data appear most consistent with non-separable preferences over consumption and leisure.

Keywords: Habit persistence, inattention, excess sensitivity, excess smoothness

JEL Classification: E21, D91