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The Dynamic Effects of Permanent and Transitory Labor Income on Consumption

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  • Falk, Barry
  • Lee, Bong-Soo

Abstract

This paper develops a version of the Permanent Income Hypothesis in which permanent and transitory components of consumption and labor income are explicitly accounted for. The model is used to derive a restricted vector autoregressive representation of adjusted measures of consumption and saving, which is used to test the theory and to study the dynamic effects of the two • components of labor income on consumption. We find that the restrictions on the VAR are not easily rejected for quarterly post-war U.S. data. An analysis of the restricted VAR leads us to conclude that consumption can be almost entirely explained in terms of the permanent component of labor income.

Suggested Citation

  • Falk, Barry & Lee, Bong-Soo, 1991. "The Dynamic Effects of Permanent and Transitory Labor Income on Consumption," ISU General Staff Papers 199102010800001219, Iowa State University, Department of Economics.
    • Handle: RePEc:isu:genstf:199102010800001219
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    References listed on IDEAS

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    1. Blanchard, Olivier Jean & Quah, Danny, 1989. "The Dynamic Effects of Aggregate Demand and Supply Disturbances," American Economic Review, American Economic Association, vol. 79(4), pages 655-673, September.
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    4. Falk, Barry & Lee, Bong-Soo, 1990. "Time-series implications of Friedman's Permanent Income Hypothesis," Journal of Monetary Economics, Elsevier, vol. 26(2), pages 267-283, October.
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    6. Quah, Danny, 1990. "Permanent and Transitory Movements in Labor Income: An Explanation for "Excess Smoothness" in Consumption," Journal of Political Economy, University of Chicago Press, vol. 98(3), pages 449-475, June.
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