On the Validity and Refinement of the Use of Rainfall as Instrument for Transitory Income

Surach Tanboon
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Surach Tanboon: Bank of Thailand

No 2005-10, Working Papers from Monetary Policy Group, Bank of Thailand

Abstract: Given that rainfall is externally provided by nature and that it is also correlated with rural income, rainfall shocks seem to be the perfect instrument, as adopted in a popular interpretation of Paxson (1992). However, there are two problems with this reinterpretation: weak instruments and first-stage misspecification. After finding that rainfall is weakly correlated with income, I use Moreira's (2003) pivotal statistics to retest the hypothesis that the propensity to save out of transitory income is one, but still cannot reject the null. Later I find that there are previously untested assumptions on the income equation, and in fact the data indicate that they are invalid. In a new specification the propensity is found to be less than unity.

JEL-codes: C12 D91 O16 (search for similar items in EconPapers)
Pages: 33 pages
Date: 2005-01
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