Testing the Permanent Income Hypothesis with Classification Methods

Abstract

We use modern cross-sectional data and methods to conduct Friedman's (1957) classification tests of the Permanent Income Hypothesis. Our data are much superior to those available to Friedman and allow us to perform tests Friedman could not do. Some of our tests also benefit from econometric advances since Friedman published. The tests use different identifying restrictions than either Euler equation or consumption function tests, thus complementing those tests and adding considerable robustness to tests of the PIH. The results provide overall but not universal support for the PIH.

Keywords: Classification Methods, Instrumental Variables, Permanent Income Hypothesis, Cross-Section Data

JEL Classification: E21