Life Cycle-permanent Income Hypothesis Research Articles

Income variation and excess sensitivity of goods-intensive leisure

We investigate the life-cycle permanent income hypothesis (LCPIH) by estimating the effect of exogenous and predictable income variation on students’ signout activity. Students at the United States Air Force Academy (USAFA) receive monthly stipends that cannot be influenced by their labor supply but have considerable and predictable monthly variation. We also observe their absences from campus, which students are required to document on detailed signout logs, and we believe reflect specifically goods-intensive leisure such as dining and entertainment. We estimate the effect of pay variation on leisure choices using difference-in-differences. A $100 increase in monthly income induces 1.8 additional hours off base and increases the frequency of longer-duration trips. Students also record 27 percent more time away from campus than average in weeks when they receive their monthly stipend. These results suggest a departure from the LCPIH using a novel outcome and in a setting where liquidity constraints and imperfect information do not appear to explain the patterns.

Credit constraints in Colombia: evidence from the use of credit cards among low- and middle-income individuals

PurposeThe authors estimate the determinants of the value of purchases of semi-durable goods using permanent and transitory income, and the demographic characteristics of customers. The purpose is to identify whether individuals face remaining liquidity constraints, and how this friction affects their purchases.Design/methodology/approachThis study uses anonymized data of 516,525 credit card holders, with more than 7,501,065 records of purchases between 2010 and 2015. The authors decompose the income of individuals into permanent and transitory components to test the prevalence of the life cycle–permanent income hypothesis (LC–PIH). Determinants of the value of purchases for constrained and unconstrained consumers are estimated, considering the period in which individual characteristics are valid, the decisions not to make purchases in some months, and the potential endogeneity of the interest rate and the transitory component of income.FindingsThe authors present evidence of liquidity constraints for individuals who have used a high percentage of the credit limit on their cards. For these restricted customers, the value of purchases is inelastic to the interest rate, whereas the response is sizable for customers who are less restricted. The restricted customers increase the value of purchases when faced with increases in their credit limit. The elasticity of the value of purchases of semi-durable goods to permanent income is less than that for transitory income; regardless of the constraints, this still supports the LC–PIH.Research limitations/implicationsThis credit card is targeted at low- and middle-income individuals in Bogotá. Although the results might be considered as indicative of the behavior of those with similar characteristics in Colombia, the authors regard this work as the study of a particular case. A limitation of this work is that the authors do not have alternative sources of credit at an individual level.Practical implicationsThe broad credit channel of monetary policy does not apply to the restricted customers. This should be considered not only by the monetary authority, to understand the true extent of this policy, but also by the financial institutions that use this business model. The monetary authority should be cautious not to overreact when intervening in the money market to try to prompt an adequate consumer response.Social implicationsFinancial institutions have the policy of modifying the credit limits of their customers' credit cards which affects the well-being of restricted customers. Given that the card is aimed at low and middle income individuals, the credit limits of customers who use a high percentage of their credit limit might be increased.Originality/valueThis is the first paper to study liquidity restrictions with a retail credit card in Colombia and Latin America using information on customers' characteristics. The results are highly relevant for the implementation of monetary policy.

The Drifting Influence of Hall's Random-Walk Hypothesis on Consumption Modeling

Abstract Hall's 1978 article titled “Stochastic Implications of the Life Cycle–Permanent Income Hypothesis” was meant to revolutionize consumption modeling. It indeed delivered, but not by becoming the dominant modeling strategy, but by unleashing a complex process of interaction between researchers in consumption and interconnected fields that transformed Hall's original object, from a local theory of consumption into a growing research area spanning the fields of consumption, finance, monetary policy and econometric modeling, and becoming, at the turn of the century, a building block of the DSGE modeling framework. Researchers reacting to innovative work produced new models that acted modified the context of research inducing a feedback system responsible for a connected set of innovations in the fields mentioned above. Along that process the practice of consumption modeling drifted away from Hall's original proposal, suggesting the necessity of a more nuanced view of the notion of influence in contemporary macroeconomics. In this particular case, we found that drifting occurred within the bounds set by the Euler equation and the assumptions of intertemporal optimization and rational expectations.

The Relationship between Consumption and CO2 Emissions: Evidence for Portugal

This paper establishes an empirical relationship between CO2 emissions from burning fossil fuels and household consumption of nondurable goods and services. Using a typical life cycle-permanent income hypothesis framework, we reject the hypothesis that inclusion of CO2 emissions in the consumption function is not supported by the data. Furthermore, our results suggest the existence of a distaste effect or negative state dependence effect. This result has important policy implications as it suggests that decarbonizing the economy would ultimately stimulate household consumption. Our results also have implications for both the cyclical behavior and the smoothing process of consumption, which depend on the branch of the environmental Kuznets curve that the country is on as well as on the prevalence of intertemporal dependent preferences.

Variations in farm consumption and their relationship to income: an empirical investigation of Illinois farm households

ABSTRACTEmpirical tests of household consumption have yielded mixed results regarding the validity of the life cycle/permanent income (LCPI) hypothesis. A significant problem with such studies is the difficulty in finding sufficient micro-level data on household expenditures. By using the recent rich quantity of such data in the Farm Business Farm Management (FBFM) data for Illinois farms from 1995 to 2009, the study reported here for farm households should provide more consistent results regarding the LCPI hypothesis. Applying an empirical model based on the LCPI hypothesis, this article identifies the determinants of farm consumption and the relationship to income. This study provides evidence that current income changes are not significant in explaining the consumption changes of farm households, thus supporting the LCPI hypothesis for farm households.

RATIONAL CONSUMERS*

The life cycle/permanent income hypothesis (LCPIH) entails two postulates: People have rational expectations and people do not have problems with self‐control. If either or both of these postulates do not apply, we cannot obtain a testable implication for the LCPIH. We use Japanese representative panel data that include responses to self‐reported and retrospective questions in order to elicit behavior such as forward‐looking and self‐control problems. We test the rational expectations hypothesis and the LCPIH implication and find that rational consumers do not change their expenditure in response to expected income changes, which we restrict to fit the two LCPIH postulates.

Testing the Rational Expectations Permanent Income Hypothesis for Developing Countries

The aim of this study is to estimate a consumption model for developing countries. For this purpose, Life Cycle-Permanent Income Hypothesis under rational expectations is estimated with the data collected from 54 countries in three different income groups. In the study, static panel data analysis method is applied using annual data for the period of 2000-2011 for each country. According to the empirical results for low income countries, no statistically significant findings were obtained. On the other hand, while the results are statistically significant, lower and upper middle income countries are excess sensitive to current income level. Hence Rational Expectations Life Cycle-Permanent Income Hypothesis is not seen valid for developing countries. This finding is derived from liquidity constraints, precautionary saving incentive and myopic effects based on households’ decisions.

Financing the elderly in Indonesia

In developing countries, where the informal labor sector is large, the pay-as-you-go pension system is inapplicable. However, in order to maintain the distributional effect of a pension system, a kind of cash transfer for the elderly, taken from consumption taxes, is applicable. This notion of applying consumption taxes for older people's income is novel as it has never been applied anywhere, not even in Indonesia. This study analyzes how the capacity of consumption tax in Indonesian provinces is able to finance the economic lives of the elderly. The methodology and steps taken in this research are as follows: (a) Identifying consumption function for each province by using the life cycle-permanent income hypothesis (LCPIH) consumption function econometric model; (b) Predicting consumption function according to population trajectory for each province by using the Arima econometrics model; (c) Predicting the necessary amount to finance the elderly; and (d) Calculating the deficits (surplus) of the consumption tax under the older person financing. The findings are as follows. From the 30 provinces observed, four provinces show a low marginal tax rate (ranges lower than 2 per cent). While 13 provinces have a medium marginal tax rate (ranges from 2 to 4 per cent), the remaining 13 provinces show a high marginal tax rate (4 per cent and above). In addition, from the 30 provinces observed, 10 provinces show decreasing marginal tax indicators, three provinces show relatively constant marginal tax indicators, and the remaining 17 provinces show increasing marginal tax indicators. The conclusions are, first, that consumption taxes are applicable in Indonesia to finance the economic lives of the elderly; and second, that because not all Indonesian provinces are able to levy this type of tax without charging an overly high tax rate, some of the provinces that are not capable should seek assistance from the central government in terms of a block grant.

Do households smooth expenditure over anticipated income changes? Evidence from bonus payments to public employees in Japan

This paper provides new evidence of consumers’ reaction to an anticipated sizable change in income. Until FY2002, Japanese public employees received predictable large bonus payments three times a fiscal year (in June, December, and March), but the March bonus was abolished in FY2003. We compare the seasonal patterns of public employees’ expenditure before and after the reform of the bonus payment schedule. Contrary to the prediction of the life cycle/permanent income hypothesis (LC/PIH), we find evidence that monthly patterns of household expenditure were significantly affected by the anticipated large change in income pattern. However, at closer inspection, this excess sensitivity of expenditure is observed only for expenditure subcategories of some durability, i.e., durables and semi-durables. Thus, while the LC/PIH does not appear to hold for expenditure (which we observe here), it may still hold for consumption.

收入分配、总消费、与相对收入假说：一个文献述评 (Income Distribution, Aggregate Consumption, and Relative Income Hypothesis: A Literature Review)

本文围绕收入分配与社会总消费之关系这一题目，对消费理论在西方学界的发展作了简要的梳理，并由此阐明，相对收入假说是唯一完全符合现有主要经验事实的消费理论，而各种形式的“绝对收入理论”即以绝对收入水平来解释个体消费的理论，包括凯恩斯的绝对收入假说以及主流的生命周期——持久收入假说，都无法与现有经验事实完全相容。这表明，只有相对收入假说适合作为解释个体消费行为，以及讨论收入分配与总消费之间关系的基本理论框架。本文指出，由于受西方主流学界之偏见的影响，国内学界对相对收入假说的认识和研究都处于起步阶段而显得严重不足。未来一段时间，无论是研究消费理论本身，还是讨论收入分配对总消费的影响，中国学者都应当把相对收入假说作为一个当务之急的研究重点。 This paper conducts a succinct review of the development of consumption theory in the West, in relation to the question of whether and how income distribution affects aggregate consumption, thereby showing that the relative income hypothesis (RIH) is the only consumption theory that is consistent with the existing empirical findings. On the other hand, the various “absolute income theories”, i.e. consumption theories which make individual consumption depend on absolute income levels, including Keynes’ absolute income hypothesis (AIH) and the mainstream life cycle-permanent income hypothesis (LCH-PIH), are all incompatible with the existing empirical evidence in one way or another. Hence, only RIH is acceptable as the basic theoretical framework for understanding individual consumption behavior, and thus for exploring the relation between income distribution and aggregate consumption. We further point out that, due to the biased influence of the mainstream economics in the West, the understanding and research of RIH are seriously inadequate in China. In the foreseeable future, RIH should be a top priority for Chinese researchers, both regarding the study of consumption theory per se and in relation to the discussion of whether China’s growing income inequality has adversely affected its internal demand.

The Life-Cycle Hypothesis and Differential Replacement Rates

To test some of the implications of the life cycle-permanent income hypothesis we exploit dierences in expected retirement replacement rates between lowly and highly educated households. We examine education-specic age-wealth proles at the household level. Our sample is an unbalanced panel of 17 years (1994-2010) and approximately 2000 households of Dutch data (DNB Household Survey). We nd that, even after controlling for permanent income, highly educated households accumulate more wealth during working life than lowly educated households. A possible explanation is the lower retirement replacement rate of the former group. Furthermore, only highly educated households seem to decumulate wealth after retirement.

The Simplest Possible Presentation of the Life Cycle-Permanent Income Hypothesis and Ricardian Equivalence

In this paper, a set of simple numerical examples are used to illustrate the essence of the life cycle-permanent income hypothesis and Ricardian equivalence. The level of mathematical sophistication required of the reader is nothing more than grade school arithmetic. Since the simple Keynesian absolute income theory of consumption requires nothing more than elementary school mathematical competence, the playing field of the various theories is leveled for the novice reader.

The long run relationship between private consumption and wealth: common and idiosyncratic effects

We investigate the long run relationship between private consumption, disposable income and wealth approximated by equity and house price indices for a panel of 15 industrialized countries. Consumption, income and wealth are cointegrated in their common components. The impact of house prices exceeds the effect arising from equity wealth. The long run vector is broadly in line with the life cycle permanent income hypothesis, if house prices are allowed to enter the relationship. At the idiosyncratic level, a long run equilibrium is detected between consumption and income, i.e. the wealth variable can be excluded. The income elasticity in the idiosyncratic relationship is significantly less than unity. Hence, the presence of wealth effects in consumption equations arises from the international integration of asset markets and points to the relevance of risk sharing activities of agents. Without sufficient opportunities, an increase in national saving rates would be expected, leading to a lower path of private consumption expenditures.

Consumption in South America: myopia or liquidity constraints?

In this paper, we consider Brazil, Colombia, Peru, and Venezuela for a study on aggregate consumption behavior, in which we test the life cycle-permanent income hypothesis prediction that consumption growth depends only on the interest rate. Nevertheless, our results suggest that in general predicted income is a relevant covariate. We checked for some possible reasons behind this result, namely liquidity constraints, myopia and perverse asymmetry. We found support for liquidity constrained consumers in Brazil and Colombia, and perverse asymmetry for Peru. Finally, the results were uninformative about consumption in Venezuela.

Heterogeneity in Intra-Monthly Consumption Patterns, Self-Control, and Savings at Retirement

Using data from the Continuing Survey of Food Intake by Individuals, this paper describes the shape of consumption profiles over the month for Social Security benefit recipients that have saved different amounts for retirement. Individuals with income mostly made up of Social Security and savings smooth consumption over the pay period, while individuals without savings consume 25 percent fewer calories the week before they receive checks relative to the week afterwards. The findings for individuals without savings, who comprise about a fourth of our sample, are inconsistent with the standard Life Cycle-Permanent Income Hypothesis but are consistent with hyperbolic discounting. (JEL D14, E21, J26)

MODEL TABUNGAN RUMAH TANGGA (Kajian Literatur)

Household saving, as a part of social saving, is one of the sources of fund for investment and development. It means it is necessary to organize what so called saving mobilization to push investment and to ensure the development program. Meanwhile, the model and behavior towards household saving always change from time to time due to varied and complex determining factors. Therefore, the household saving model should be conducted for policy analyzis. Household saving model could be derived from Classic, Keynes, Life Cycle Hypothesis (LCH), Permanent Income Hypothesis (PIH), Relative Income Hypothesis (RIH), Overlapping Generation Model (OLG), Rational Expectation (Ratex) and Life Cycle-Permanent Income Hypothesis (LC-PIH). The purpose of this article is to review the theoretical literature and empirical result on the household saving model.

Disentangling Insurance and Information in Intertemporal Consumption Choices

The textbook version of the life-cycle perma-nent income hypothesis with no liquidity con-straints predicts that consumption should react very mildly to (unanticipated) transitory income changes and very strongly to permanent ones. This prediction has important policy implica-tions in understanding the response of consum-ers to tax rebates or increases that are made for stabilization purposes. In recent years there has been a resurgence of interest in estimating these important parameters, either using quasi-experimental data (such as randomization of the timing when tax rebate checks are received by households; see David Johnson, Jonathan Parker, and Nicholas Souleles 2006), or imposing struc-tural restrictions on the stochastic income pro-cess faced by consumers (Orazio Attanasio and Nicola Pavoni 2008; Richard Blundell, Luigi Pistaferri, and Ian Preston 2008; Jonathan Heathcote, Kjetil Storesletten, and Giovanni L. Violante 2007; Giorgio Primiceri and Thijs van Rens, forthcoming).The main objection of quasi-experimental stud-ies is that the results may be context-specific. The main problem with the second strand of the litera-ture is that estimates of the response of consump -tion to income shocks may confound two issues, insurance and information. On the one hand, the estimate reflects the ability (or lack thereof) of the household to smooth consumption through a variety of channels, such as self-insurance, gov -ernment-provided insurance, credit markets, or other informal mechanisms. On the other hand, the identification strategy requires the ability to statistically separate what is a shock from what is an anticipated event (when seen from the point of

The Role of Asset Markets for Private Consumption: Evidence from Paneleconometric Models

We explore the long and short run relationship between private consumption, disposable income and housing and financial wealth approximated by price indices for a panel of industrialized countries. Consumption, income and wealth are cointegrated in their common, but not in their idiosyncratic components. This stresses the relevance of international spillovers to explain aggregate consumption behaviour. The cointegrating vector is robust and in line with the life cycle permanent income hypothesis. The income elasticity does not differ from unity, and wealth elasticities are within a range of 2 to 5 percent. According to the error correction mechanism, consumption could not be interpreted as a weakly exogenous series.

The current account and stock returns

In this paper, I use stock return data to test an intertemporal model of the current account. I find that the model performs well in three countries: the U.K., Canada, and Japan. Hall [Hall, R.E., 1978. Stochastic implication of the life cycle-permanent income hypothesis: theory and evidence. J. Polit. Econ. 86 (6), 971–987] points out that because stock price predicts the future state of the economy, it predicts consumption. Assuming that consumption depends on permanent income, my empirical finding indicates that a representative agent smoothes consumption based on stock market information. In other words, stock market returns yield information about permanent income.

Decomposing interregional differentials in productivities: An empirical analysis for Japanese data

We propose a method for decomposing interregional differentials in productivities based on the Lifecycle Permanent Income Hypothesis. We also conduct an empirical analysis using Japanese prefectural data and examine the effectiveness of this method.