Abstract
This paper tests the permanent income hypothesis (PIH) for public consumption. Unlike private agents, a government is a representative national, infinitely-lived agent that usually faces no liquidity constraints. Thus, the expectation is that the PIH restrictions should not be rejected for public consumption. However, using U.S. data, the paper is unable to find evidence supporting the permanent income model of public consumption. Public consumption is found to be sensitive to lagged public income and too smooth relative to permanent public income. The results therefore cast doubt on the characterization of the public sector as a social welfare optimizing agent.
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