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psv140a

# psv140a - University of California Department of Economics...

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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 t-1 . (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 t-1 , consumption falls in year t-1 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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psv140a - University of California Department of Economics...

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