University of California
D. Steigerwald
Department of Economics
Economics 140A
Problem Set V
1.
Consider the following empirical results concerning the Permanent Income Hypothesis
(PIH). With data for the US from 1981 through 1994,
in which all data are measured as
per capita real quantities:
)
002
(.
2
,
1
1
,
1
)
137
(.
,
006
.
227
.
1
.
3
−
−
+
+
=
t
t
t
x
x
y
where
t
y
is the growth rate of consumption in year
t
. The regressors
1
,
1
−
t
x
and
2
,
1
−
t
x
are
the mean and variance, respectively, of the income growth rate for year
t
. Because the
mean and variance are expectations of what happens in year
t
, they are made in year
t1
.
(The estimated standard errors appear in parentheses below each estimate.)
a.
How would you interpret the preceding regression?
b.
Under the PIH, individuals consume on the basis of expected future income. As such,
expected future income should not help explain consumption growth and the coefficient
on expected income growth (
1
,
1
−
t
x
) should be zero. Test the PIH by testing the null
hypothesis that the coefficient (on expected income growth) is zero against the alternative
hypothesis that the coefficient is not zero. Do your results support the PIH?
b.
Under the PIH, individuals reduce consumption as income becomes less certain. If the
variance of future income increases in year
t1
, consumption falls in year
t1
but does not
necessarily fall in year
t
. As such, the PIH hypothesis implies that the coefficient on
income growth uncertainty (
2
,
1
−
t
x
) is positive. Test the PIH by testing the null hypothesis
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 Fall '08
 Staff
 Economics, Null hypothesis, Consumption function, Permanent income hypothesis, PIH

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