Changes In Permanent Income Research Articles

La hipótesis del ingreso permanente y la función de consumo de Ecuador. Evidencia para el periodo 2000 – 2018

Este estudio tiene como objetivo estimar una función de consumo privado agregado para la economía de Ecuador. Para ello, se contrasta la relevancia de la hipótesis de ingreso permanente de Friedman (1957) como descripción aproximada del consumo del país. Con la finalidad de comprobar empíricamente, se utilizó información trimestral durante el período 2000:q1-2018:q4, misma que fue modelada en una estimación de dos regresiones lineales basadas principalmente en el modelo racionalizado de Koyck (Gujarati y Porter, 2010), utilizando Mínimos Cuadrados Ordinarios (MCO) y Mínimos Cuadrados Ordinarios en 2 Etapas (MC2E). Los resultados sugieren que el consumo agregado en Ecuador se ajusta al nivel de ingreso real con un rezago considerable. Lo que permite evidenciar a favor de la hipótesis del ingreso permanente, en el sentido de que el gasto de consumo de los hogares responde más a los cambios en el ingreso permanente que al ingreso transitorio o del período corriente.

New dynamics of consumption and output

Since the mid-1980s, the volatility of major macro variables has decreased remarkably, known as the Great Moderation. Even though a great deal of literature addresses the sources of the Great Moderation, its association with potential changes in the dynamics of consumption or output has not been investigated rigorously. This paper reports two empirical findings: i) a faster adjustment of output to changes in its long-run random walk component and ii) a faster adjustment of consumption to changes in permanent income (as approximated by the random walk component of real output) since the mid-1980s. Our interpretation is that a faster diffusion of technology shocks induced by improved information technology may be responsible for the former. In the presence of precautionary savings, a change in the consumer behavior induced by lower uncertainty about future income may be responsible for the latter. The change in output dynamics itself may also be responsible for the change in consumer behavior, as implied by Deaton (1991).

Income Polarization in the United States

The paper uses a combination of micro-level datasets to document the rise of income polarization—what some have referred to as the “hollowing out” of the income distribution—in the United States, since the 1970s. While in the initial decades more middle-income households moved up, rather than down, the income ladder, since the turn of the current century, most of polarization has been towards lower incomes. This result is striking and in contrast with findings of other recent contributions. In addition, the paper finds evidence that, after conditioning on income and household characteristics, the marginal propensity to consume from permanent changes in income has somewhat fallen in recent years. We assess the potential impacts of these trends on private consumption. During 1998-2013, the rise in income polarization and lower marginal propensity to consume have suppressed the level of real consumption at the aggregate level, by about 3½ percent—equivalent to more than one year of consumption.

Return Chasing and Investments: Evidence from the Housing Market

Using a nationally representative sample of wealthy home owners and their investment records during the recent housing boom, I show that investors reporting high home value appreciation on their own primary residences in the past are more likely to make future investments in the housing market by remodeling their home or purchasing a new investment property. The impact of perceived returns from the past on future investment decisions is short-lived and hump-shaped, roughly doubles in size during the peak of the housing boom, and is much stronger for younger investors. This investment strategy does not appear to be driven by an increase in wealth, (expected) changes in permanent income, relaxed credit constraints through rising collateral values, willingness to take nancial risks, or the q of the house. Further decomposing perceived returns on housing using zip code level returns, home owners' subjective valuation of their own homes is found to be chie y responsible for the observed investment strategy. These ndings suggest that feedback from return to expectation to behavior may have ampli ed the housing boom. ∗I am grateful to my committee members Jonathan Parker (Chair), Annette Vissing-Jorgensen (Co-Chair), Meghan Busse, and Paola Sapienza for helpful guidance and insightful comments. I also thank Snehal Banerjee, Efraim Benmelech, David Hirshleifer, Arvind Krishnamurthy, Camelia Kuhnen, David Matsa, Robert McDonald, Brian Melzer, Mitchell Petersen, Anthony Wray, and seminar participants from Kellogg for constructive suggestions. Generous nancial support for this paper from the NBER Household Finance Working Group, the Alfred P. Sloan Foundation, the Zell Center for Risk Research, and the Department of Finance at Kellogg School of Management is gratefully acknowledged. All errors are my own. This paper was previously titled Return Chasing and Investments: Evidence from the Housing Market . ©In Gu Khang. All rights reserved. 699 Boylston Street, Boston, MA 02116. E-mail: i-khang@cornerstone.com

A Lintner Model of Payout and Managerial Rents

ABSTRACTWe develop a dynamic agency model in which payout, investment, and financing decisions are made by managers who attempt to maximize the rents they take from the firm, subject to a capital market constraint. Managers smooth payout to smooth their flow of rents. Total payout (dividends plus net repurchases) follows Lintner's (1956) target adjustment model. Payout smooths out transitory shocks to current income and adjusts gradually to changes in permanent income. Smoothing is accomplished by borrowing or lending. Payout is not cut back to finance capital investment. Risk aversion causes managers to underinvest, but habit formation mitigates the degree of underinvestment.

A Lintner Model of Payout and Managerial Rents

We develop a dynamic agency model where payout, investment and financing decisions are made by managers who attempt to maximize the rents they take from the firm, subject to a capital market constraint. Managers smooth payout in order to smooth their flow of rents. Total payout (dividends plus net repurchases) follows Lintner's (1956) target-adjustment model. Payout smooths out transitory shocks to current income and adjusts gradually to changes in permanent income. Smoothing is accomplished by borrowing or lending. Payout is not cut back to finance capital investment. Risk aversion causes managers to underinvest, but habit formation mitigates the degree of underinvestment.

Today Versus tomorrow: The Sensitivity of the Non-Oil Current Account Balance to Permanent and Current Income

This paper applies the Permanent Income Model to the non-oil current accounts of the major oil exporters to assess the extent to which national consumption decisions in these countries are made on the basis of permanent versus current income. A test of whether the return on oil wealth and oil balance coefficients sum to unity is accepted for all specifications that adjust the return on wealth for future population changes. For oil-exporting countries outside Africa, around half of the fluctuations in the private sector non-oil balance are driven by considerations of changes in permanent income (the return on oil wealth) rather than current income. By contrast, for the public sector and African countries permanent income has little or no effect.

Heterogeneous life-cycle profiles, income risk and consumption inequality

Was the increase in income inequality in the US due to permanent shocks or merely to an increase in the variance of transitory shocks? The implications for consumption and welfare depend crucially on the answer to this question. We use Consumer Expenditure Survey (CEX) repeated cross-section data on consumption and income to decompose idiosyncratic changes in income into predictable life-cycle changes, transitory and permanent shocks and estimate the contribution of each to total inequality. Our model fits the joint evolution of consumption and income inequality well and delivers two main results. First, we find that permanent changes in income explain all of the increase in inequality in the 1980s and 1990s. Second, we reconcile this finding with the fact that consumption inequality did not increase much over this period. Our results support the view that many permanent changes in income are predictable for consumers, even if they look unpredictable to the econometrician, consistent with models of heterogeneous income profiles.

Donations in a recursive dynamic model

Abstract. This paper studies how donations respond to unexpected permanent changes in income and tax rates in a recursive dynamic model. The dynamic approach yields several interesting insights. If marginal tax rates are progressive, a permanent jump in a household's income increases its consumption and donations in the short run, but has no effect in the long run. The permanent income elasticity of current donations is likely to exceed one. If the marginal tax rate is flat, the jump in income raises consumption and donations in both the short and the long run. A permanent marginal tax rate cut raises consumption and donations in the long run if marginal tax rates are progressive, while it reduces donations in the short run if it has little direct impact on tax payments. If the marginal tax rate is flat, a tax cut has a positive effect on consumption in both the short and the long run, but has an ambiguous effect on donations.

Predictable Life-Cycle Shocks, Income Risk and Consumption Inequality

Was the increase in income inequality in the US due to permanent shocks or merely to an increase in the variance of transitory shocks? The implications for consumption and welfare depend crucially on the answer to this question. We use CEX repeated cross-section data on consumption and income to decompose idiosyncratic changes in income into predictable life-cycle changes, transitory and permanent shocks and estimate the contribution of each to total inequality. Our model fits the joint evolution of consumption and income inequality well and delivers two main results. First, we find that permanent changes in income explain all of the increase in inequality in the 1980s and 90s. Second, we reconcile this finding with the fact that consumption inequality did not increase much over this period. Our results support the view that many permanent changes in income are predictable for consumers, even if they look unpredictable to the econometrician, consistent with models of heterogeneous income profiles

Heterogeneous Life-Cycle Profiles, Income Risk and Consumption Inequality

Was the increase in income inequality in the US due to permanent shocks or merely to an increase in the variance of transitory shocks? The implications for consumption and welfare depend crucially on the answer to this question. We use CEX repeated cross-section data on consumption and income to decompose idiosyncratic changes in income into predictable life-cycle changes, transitory and permanent shocks and estimate the contribution of each to total inequality. Our model fits the joint evolution of consumption and income inequality well and delivers two main results. First, we find that permanent changes in income explain all of the increase in inequality in the 1980s and 90s. Second, we reconcile this finding with the fact that consumption inequality did not increase much over this period. Our results support the view that many permanent changes in income are predictable for consumers, even if they look unpredictable to the econometrician, consistent with models of heterogeneous income profiles.

Permanent income and transitory variation in investment and output

We use the permanent income hypothesis as the framework to analyze a number of results from recent empirical macroeconomic research. First, we demonstrate that the “productivity” shock isolated in both the three- and six-variable models of King et al. [Am. Econ. Rev. 81 (1991) 819] depend mainly on the time-series behavior of the reduced form consumption residual. A permanent income hypothesis interpretation of this finding is that consumption fully reflects the implications of long-lived shocks for the common stochastic trend in consumption, investment and output. Further, for the three-variable model, shocks to consumption have permanent effects on the levels of the series while shocks to investment and output have only transitory effects, given that consumption is ordered first in a causal ordering. The permanent income interpretation is that shocks to productivity are changes in permanent income, and hence, are fully reflected through consumption decisions. From this perspective, consumption shocks are proxies for the changes in permanent income generated from the “productivity” shocks. The results complement the findings in Hall [J. Polit. Economy 96 (1978) 339], Campbell [Econometrica 55 (1987) 1249] and generalizes Cochrane’s [Quart. J. Econ. 109 (1994) 241] analysis to a model that includes investment.

Permanent Income and Transitory Variation in Investment and Output

The authors use the permanent income hypothesis as the framework to analyze a number of results from recent empirical macroeconomic research. First, they demonstrate that the shock isolated in both the three and six variable models of King, Plosser, Stock, and Watson (1991) depends mainly on the time-series behavior of the reduced form consumption residual. A permanent income hypothesis interpretation of this finding is that consumption fully reflects the implications of long-lived shocks for the common stochastic trend in consumption, investment, and output. Further, for the three variable model, shocks to consumption have permanent effects on the levels of the series while shocks to investment and output have only transitory effects, given that consumption is ordered first in a causal ordering. The permanent income interpretation is that shocks to productivity are changes in permanent income, and, hence, are fully reflected through consumption decisions. From this perspective, consumption shocks are proxies for the changes in permanent income generated by the shocks. The results complement the findings in Hall (1978) and Campbell (1987) and generalize Cochrane's (1994) analysis to a model that includes investment.

Transitory and permanent disturbances and the current account: an empirical analysis in the intertemporal framework

The intertemporal models of current account determination demonstrate that in the analysis of the current account balance of a country, it is important to distinguish between transitory and permanent disturbances in income and relative prices. This paper attempts to decompose the observed data on income and real exchange rate into transitory and permanent components and then uses the decomposed series to test the empirical validity of the predictions of the intertemporal models. Evidence from the United States and Japan provide very limited support for the intertemporal models in terms of the effects of transitory and permanent changes in income on current account balance. For both US and Japan, the study finds that permanent changes in real exchange rate have significant effects on the current account balance. Statistical tests find no evidence of hysteresis in the trading relations of the two countries.

The Effect of Income on Child Development

This study presents estimates of the effect of parental income on children's cognitive, social, and emotional development. The effect of current income is small, especially when income is treated as endogenous. The effect of “permanent” income is substantially larger, but relatively small when compared to the magnitude of recent policy-induced changes in income. Family background characteristics play a more important role than income in determining child outcomes. Policies that affect family income will have little direct impact on child development unless they result in very large and permanent changes in income.

Income Effects on the Trade Balance

This paper investigates the income effects on the trade balance with particular attention to the distinction between permanent and transitory disturbances for the United States, Japan, Germany, and the United Kingdom. In all four countries, movements in the trade balance have mostly been associated with transitory changes in income. The latter also are negatively associated with the trade balance. In marked contrast, permanent changes in income have little to do with the trade balance. These results are examined in light of intertemporal models and real business cycle models. Copyright 1996 by MIT Press.

Consumption Taxes in a Life-Cycle Framework: Are Sin Taxes Regressive?

In this paper we construct measures of tax incidence over the life-cycle and compare these measures to traditional measures based on annual data. We show that annual measures of the incidence of taxes on consumption goods may differ from life-cycle measures for three reasons. First, annual measures of income reflect transitory components which should have smaller effects on consumption than permanent changes in income. Second, income measured in a single period differs from lifetime income due to age-related differences in earnings. Third, consumption of certain items follows life-cycle patterns independent of changes in income. Surprisingly, we find that these effects cause almost no change in the assessment of the incidence of taxes applying to the consumption of cigarettes. For alcohol, however, we find that a tax on its consumption is slightly less regressive when measured with respect to lifetime income than when measured with respect to annual income.

Empirical Tests of the Rational Expectations - Permanent Income Hypothesis: Evidence from Pakistan

The permanent income hypothesis postulates that at a given point in time, an individual's consumption is determined by his lifetime resources and not by his income. Thus, the hypothesis suggests that an individual's consumption will respond only to changes in permanent income. The insertion of the rational expectations theory into Friedman's permanent income hypothesis by Hall (1978),-called the Rational Expectations/Permanent Income Hypothesis (thereafter RE/PIH)changed this view, and suggested that current aggregate consumption is determined only by its own lag. Any information that may help in determining current consumption is already included in last period's consumption. Hence consumption follows a random walk. The testable implication of Hall's hypothesis is that apart from the current period's consumption expenditure, any variable observable in this or earlier periods should not show any predictive power for the next period's consumption expenditure. Therefore, additional lagged values of consumption or any other variable that can reasonably be assumed to be in the consumer's information set at time t should not be statistically significant if regressed over current consumption.

Partial adjustment and the permanent income hypothesis

The paper extends the permanent income hypothesis to incorporate two alternative theories of partial adjustment. The first is the conventional forward-looking quadratic costs of adjustment model; the second develops the idea that adjustment of consumption to changes in permanent income are faster the more advanced is the notice of such changes. Both theories can in principle account for the ‘excess smoothness’ and ‘excess sensitivity’ phenomena highlighted in recent research. Both models are applied to U.S. and U.K. quarterly data. The second model appears to provide a more satisfactory explanation of consumption in the two countries.

ANTICIPATED AND UNANTICIPATED INCOME WITHIN THE CONSUMPTION FUNCTION: A RATIONAL EXPECTATIONS APPROACH

The rational expectations‐permanent income hypothesis (REPIH) is nothing new. The initial REPIH of Hall (1978) suggested that no other variable observed in earlier periods, given the inclusion of consumption lagged one period, should have any explanatory power for current consumption (Hall, p.972). The Hall version does not eliminate inclusion of current income in the explanation of consumption. Later work by Flavin (1981) finds that current income contains information about future income by providing signals to changes in permanent income. The means to reveal the innovation of current income signaling changes in permanent income has been to decompose current income into its anticipated and unanticipated components. Flavin suggests that unanticipated changes in current income may affect consumption by signaling changes in current income while anticipated changes in current income are included in the formation of permanent income thus having no affect on consumption.