Characterizing the Failure of the Permanent Income Hypothesis

Chulsoo Kim
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Chulsoo Kim: Rutgers University and Sookmyung Women's University

Korean Economic Review, 1996, vol. 12, issue 1, 5-24

Abstract: This paper characterizes the failure of the permanent income hypothesis (PIH} in terms of excess sensitivity and excess smoothness. First, this paper examines a model explaining the excess sensitivity of consumption to current income by comput-ing all the testable implications of the model and characterizing its failure in terms of the extent to which consumption deviates from the excess sensitivity of consump-tion. The model has the smallest deviation when the fraction of agents who consume their current income rather than permanent income is about 0.5. Second, this paper develops an excess smoothness test which is independent of the presence of unit roots in the labor income process. Consumption is shown to be too smooth to be justified by the PIH.

Date: 1996
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