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Income Asymmetries and the Permanent Income Hypothesis

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  • Juan Urquiza

Abstract

Within the context of the Permanent Income Hypothesis (PIH), the predictions for consumption depend crucially upon the process for income. In this paper, we consider an unobserved components model that allows for both asymmetric transitory movements and correlation between permanent and transitory innovations. Using aggregate U.S. data, we show that this model fits labor income data significantly better than common alternatives. However, we find that consumption is excessively smooth relative to the predictions of our model. To reconcile these predictions with the data, we explore the possibility of imperfect information. A delayed information version of the model fits the data better but consumption is excessively sensitive compared to the predictions of this model. We are able to match the data when we consider an economy in which 60 – 65% of consumers behave according to the PIH with full information and the remaining consumers have delayed information.

Suggested Citation

  • Juan Urquiza, 2011. "Income Asymmetries and the Permanent Income Hypothesis," Documentos de Trabajo 409, Instituto de Economia. Pontificia Universidad Católica de Chile..
    • Handle: RePEc:ioe:doctra:409
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    More about this item

    Keywords

    Unobserved Components Models; markov-Switching; consumption dynamics; excess smoothness; excess sensitivity; imperfect information;
    All these keywords.

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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