This paper develops a version of the Permanent Income Hypothesis in which permanent and transitory components of consumption and labor income are explicitly accounted for. The model is used to derive a restricted vector autoregressive representation of adjusted measures of consumption and saving, which is used to test the theory and to study the dynamic effects of the two • components of labor income on consumption. We find that the restrictions on the VAR are not easily rejected for quarterly post-war U.S. data. An analysis of the restricted VAR leads us to conclude that consumption can be almost entirely explained in terms of the permanent component of labor income.
This paper is published in Journal of Monetary Economics, Vol. 41, No. 2, 27 February 1998, Pages 371-387
Falk, Barry and Lee, Bong-Soo, "The Dynamic Effects of Permanent and Transitory Labor Income on Consumption" (1991). Economic Staff Paper Series. 186.