Income Process, Precautionary Consumption and Cyclical Consumption Fluctuations.

Abstract

Permanent Income Hypothesis (PIH) with aggregate income with unit root produces two consumption patterns that are not consistent with data observation. One is that consumption growth rate is too volatile and the second is that the response of consumption is too insensitive to lagged income change. To reconcile the data, I did the following things in this thesis: In Chapter 1, I re-investigate the income process. By adopting LM test proposed by Lee and Strazicich (2003) and allowing for the presence of two break points in either drift or trend break, the hypothesis that aggregate income has a unit root is rejected. In Chapter 2, I explain the mechanism of how precautionary consumption works to decrease the consumption volatility and re-investigate the possibility of buffer-stock model to be data consistent. Our results show that buffer-stock saving model fits the data better than PIH. In Chapter 3, I extend the model from infinite horizon to finite life span and introducing altruism incentive. By doing so, marginal propensity of consume (MPC) becomes age-varying and higher than infinite life model. The calibration also shows that short-run consumption fluctuation becomes higher under new model, which is consistent with the long-run features.