Myopia, Liquidity Constraints, and Aggregate Consumption: A Simple Test
Journal article by John Shea; Journal of Money, Credit & Banking, Vol. 27, 1995
Journal Article Excerpt
| Myopia, liquidity constraints, and aggregate consumption: a simple test. by John Shea THE NEOCLASSICAL life cycle--permanent income hypothesis (LCH/PIH) implies that predictable movements in income should not affect consumption. Recent tests using aggregate time-series data consistently reject this prediction. Campbell and Mankiw (1990), for instance, present significant estimates of the elasticity of consumption with respect to predictable income ranging from 0.351 to 0.713. While the failure of the LCH/PIH in aggregate data is well established, the reason for this failure is not. Two alternative hypotheses that have received considerable attention are myopia and liquidity constraints. This note conducts a simple test of these two alternatives using aggregate time series data.(1) The test exploits the fact that myopia and liquidity constraints have testable implications for asymmetry in consumption behavior, as first noted by Altonji and Siow (1987). Under myopia, consumption tracks current income. Thus, the failure of the LCH/PIH should be symmetric: consumption should respond equally to predictable income increases and decreases. Under liquidity constraints, however, the LCH/PIH fails only because agents cannot borrow when income is temporarily low. In this case, consumption should be more strongly correlated with predictable income increases than declines; liquidity constraints impede borrowing but not saving. The empirical evidence suggests that neither myopia nor liquidity constraints is an adequate characterization of U.S. aggregate consumption behavior. Using quarterly data from 1956-1988, I show that consumption is more sensitive to predictable income declines than increases. This "perverse asymmetry" also ... |
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