The Excess Smoothness of Consumption: Identification and Interpretation

Abstract

Deaton's observation that consumption appears to be too smooth is easily reconciled with the notion that consumption exhibits to current income. The reconciliation invokes the plausible assumption that households forecast on the basis of a larger information set than the econometrician. The empirical case for excess smoothness is strengthened by showing that the innovations in permanent income can be inferred from an autoregression of income and saving, not only under the permanent income hypothesis, but also under the excess sensitivity model. Empirically, parameter restrictions imposed on the bivariate autoregression by the excess sensitivity model are not rejected.