A Cross-country Test of the Permanent Income Hypothesis

The Permanent Income Hypothesis (PIH) predicts an income innovation has the same size effect on consumption as on permanent income, an implication we examine with a cross-country test proposed by Kormendi & LaHaye (1984). The data from industrial countries support PIH but data from developing countries do not. Also, however, data from countries with high quality national income accounts support PIH whereas data from countries with low quality accounts do not. The stage of economic development and data quality are highly correlated. The evidence suggests that the results may be driven primarily by data quality differences rather than systematically different behaviour between industrial and developing countries.