Permanent Income and Transitory Variation in Investment and Output

FRB Atlanta Working Paper No. 2001-17

31 Pages Posted: 9 Nov 2001

See all articles by Lance A. Fisher

Lance A. Fisher

Macquarie University - Department of Economics; Macquarie University, Macquarie Business School

Hyeon-Seung Huh

Hallym University - Department of Economics

Ellis W. Tallman

Federal Reserve Banks - Federal Reserve Bank of Cleveland

Date Written: October 2001

Abstract

The authors use the permanent income hypothesis as the framework to analyze a number of results from recent empirical macroeconomic research. First, they demonstrate that the "productivity" shock isolated in both the three and six variable models of King, Plosser, Stock, and Watson (1991) depends mainly on the time-series behavior of the reduced form consumption residual. A permanent income hypothesis interpretation of this finding is that consumption fully reflects the implications of long-lived shocks for the common stochastic trend in consumption, investment, and output. Further, for the three variable model, shocks to consumption have permanent effects on the levels of the series while shocks to investment and output have only transitory effects, given that consumption is ordered first in a causal ordering. The permanent income interpretation is that shocks to productivity are changes in permanent income, and, hence, are fully reflected through consumption decisions. From this perspective, consumption shocks are proxies for the changes in permanent income generated by the "productivity" shocks. The results complement the findings in Hall (1978) and Campbell (1987) and generalize Cochrane's (1994) analysis to a model that includes investment.

Keywords: permanent income, transitory shocks, structural VEC, productivity

JEL Classification: C32, E20

Suggested Citation

Fisher, Lance A. and Huh, Hyeon-Seung and Tallman, Ellis W., Permanent Income and Transitory Variation in Investment and Output (October 2001). FRB Atlanta Working Paper No. 2001-17, Available at SSRN: https://ssrn.com/abstract=288545 or http://dx.doi.org/10.2139/ssrn.288545

Lance A. Fisher

Macquarie University - Department of Economics ( email )

Sydney NSW 2109
Australia

Macquarie University, Macquarie Business School ( email )

New South Wales 2109
Australia

Hyeon-Seung Huh

Hallym University - Department of Economics ( email )

Chunchon Kangwon, 200-702
South Korea
82-33-240-1309 (Phone)
82-33-255-9109 (Fax)

Ellis W. Tallman (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Cleveland ( email )

East 6th & Superior
Cleveland, OH 44101-1387
United States

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