Reexamining the permanent income hypothesis with uncertainty in permanent and transitory innovation states

In this paper, we reexamine the permanent income–consumption relationship analytically and empirically, based on the innovation regime-switching (IRS) model developed in [Kuan, C.M., Huang, Y.L., Tsay, R.S., 2005. An unobserved component model with switching permanent and transitory innovations. Journal of Business and Economic Statistics, 23, 443–454]. A novel feature of the IRS model is that it explicitly allows for uncertainty in innovation states. When the labor income follows an IRS process, it is shown that the agent’s perception on the likelihoods of income innovations being permanent and transitory plays a crucial role in determining the optimal forecasts on the change of consumption. The effect of a current labor income innovation on consumption is a weighted average of two distinct effects resulting from permanent and transitory innovations with the weights equal to the perceived likelihoods of the respective states. Also, past innovations may affect consumption when there are revisions in the perceived likelihoods of previous states. Our empirical study on US data shows that consumption indeed reacts significantly to the perceived likelihoods of innovation states. However, even after controlling for the effect of state uncertainty, we find consumption vastly underreacts to permanent innovations in labor income but reacts about the right magnitude to transitory ones when compared with the prediction of the permanent income hypothesis. This evidence is similar to [Elwood, S.K., 1998. Testing for excess sensitivity in consumption: A state-space unobserved components approach. Journal of Money, Credit, and Banking, 30, 64–82] but in sharp contrast with that found in [Hall, R.E., Mishkin, F.S., 1982. The sensitivity of consumption to transitory income: Estimates from panel data on households. Econometrica, 50, 461–480].     

The demand for money in secular perspective: The case of Norway, 1867–1980

This paper presents some evidence from Norwegian data on some of the long-standing empirical issues of money demand. The choice of a scale variable and the issue of simultaneous equations bias is subjected to some recently developed statistical tests. The outcome favours a permanent income model of money demand. No significant simultaneity bias was detected. Various specifications of explanatory variables, like the own yield on money, interest rates and price expectations as well as the issues of price level homogeneity and stability between subperiods are also considered in the paper.     

Shaken or Stirred? Financial Deregulation and the Monetary Transmission Mechanism in Norway

Is there a credit channel for monetary policy? Has the deregulation of financial markets had any temporary or permanent effects on the monetary transmission mechanism? We present empirical evidence on these issues for Norway by estimating a dynamic system of money, credit, real income and inflation. We find that the deregulation process has not caused any permanent shifts in the long‐run demand functions. Within a small simultaneous dynamic model, there is some evidence for the credit view of the monetary transmission mechanism, as both credit and money exhibit strong and stable effects on aggregate demand. JEL classification: E50; E44; C51     

Relative prices and the demand for money

This paper examines the validity of the conventional specification of money demand with particular reference to the issue of relative prices. It is shown that the conventional money demand function is based on the assumption of weak separability of money from commodities, which forms the basis for the absence of relative prices in money demand. Empirical and presumptive evidence suggests that weak separability is not tenable, implying that relative prices are important in money demand. The inclusion of commodity prices in money demand significantly affects the interest and income elasticity estimates. Finally, it is noted that the aggregate consumption function excluding commodity prices also has no theoretical and empirical base.     

On the properties of alternative monetary rulesin an extension of Black's model

The purpose of this paper is to compare the properties of alternative monetary rules. Our framework for this analysis involves an extension of the model developed by Black (1974). We introduce permanent income into the demand for money function and allow for a distributed impact of excess demand on inflation in the Phillip's curve. It is shown that a policy of constant monetary expansion is inferior to simple output related monetary rules.     

On Income Velocity of Money,Precautionary Money Demand and Growth

A stochastic growth model with money introduced via a cash-in-advance constraint is used to analyze the behavior of the income velocity of real monetary balances and money demand. Agents can purchase consumption goods only using government issued money. The cash-in-advance constraint may become nonbinding because of the uncertainty about the realization of the state of the economy. We find that the precautionary money demand may introduce significant changes into the volatility of the income velocity if it happens almost always. Its presence can also alter the relationship between the average growth rate of money supply and the average growth rate of the economy.     

From income to consumption: measuring households partial insurance

This article computes the degree of consumption insurance with respect to transitory and permanent income shocks. The lack of income–consumption data in the US surveys forces researchers to use an empirical strategy to impute consumption. This procedure is avoided by using the Spanish Household Budget Continuous Survey, which contains true panel data on consumption and income information in the same survey. We find full insurance for transitory income shocks and partial insurance for permanent shocks for some sub-groups. For the full sample, a 10% permanent income shock induces a 4.8% permanent change in consumption, with higher insurance capacity for college, home-owner and high-wealth households. We also compute the role of durables and family income transfers as smoothing devices. The comparison of insurance level when based on true consumption data versus imputed consumption data shows that the use of imputed consumption underestimates permanent insurance.     

The transactions demand for money in the presence of currency substitution: evidence from Vietnam

Currency substitution – the use of foreign money to finance transactions between domestic residents – is widespread in low income and transition economies. Traditionally, however, empirical models of the demand for money tend to concentrate on the portfolio motive for holding foreign currency, while maintaining the assumption that the income elasticity of demand for domestic money is invariant to the degree of currency substitution. A simple re-specification of the demand for money is offered which more accurately reflects the process of currency substitution by allowing for a variable income elasticity of demand for domestic money. This specification is estimated for Vietnam in the 1990s. Using a standard cointegration framework evidence is found for currency substitution only in the long-run but well-defined wealth effects operating in the short-run.     

Back to Basics: Remittances in the Keynesian Macroeconomic Framework

This paper examines a remittance multiplier based on the short-run Keynesian equilibrium approach and shows how income may be affected by remittance inflows. We explore this through the equilibrium in the goods and money markets, where remittances can affect both consumption and the demand for real money balances. We present this simple theoretical model utilizing a standard Keynesian framework. The short-run Keynesian equilibrium approach provides insight into how remittances affect output and income, and its potential multiplier effects. The model used is indicative of a positive relationship between the marginal propensity to consume out of remittances and the multiplier. The framework also shows that remittances will have a greater impact if its marginal propensity to consume is greater than that for standard disposable income.     

Perspectives on International Trends and Dynamics in Population and Consumption

There are increasing concerns that global environmental limits may soon be met as a result of increasing numbers of people coupled with increasing consumption of resources. However, the current level and rates of growth in both consumption and population vary systematically among countries grouped according to income levels. Many high income countries have population growth rates at close to replacement levels, but their per capita consumption is consistently several times higher than low income countries. Low income countries need to grow out of poverty and have high population growth rates. Using current population structures for India and the USA in an age-structured demographic model, and simple projections of annual reductions in fertility or consumption per capita over the next 50 years, we show that while reductions in both consumption and fertility are necessary to stabilize impacts, there are short term gains from consumption reductions in high income countries such as the USA, and long term gains from early fertility reductions in growing economies such as India.     

An empirical analysis of income disparity and consumption in China

Using China’s provincial data from 1991 to 2005, this paper analyzes the impact of urban income disparity on their consumption based on static and dynamic panel data models and state space model. The GMM and Kalman Filter methods are used in the estimation and the variables such as income and price are controlled. The empirical results show that the elasticity of permanent income to consumption is much higher than that of temporary income; and the impact of income disparity on consumption is negative and substantial. A rise of 0.01 in the absolute value of Gini coefficient will cause a reduction of 0.35% in consumption on average. The effects fluctuate with the change of economic structure, consumption expectation and economic cycle. In the beginning years of 1990s, it is positive to enlarge income disparity moderately for consumption. It is the year of 1996 that the negative effect first appears in China. During 1998–2004, an increase of 0.01 to the absolute value of Gini coefficient will result in the reduction of consumption to fluctuate between 0.37% and 0.54%. In order to enlarge domestic demand and promote consumption, the focus should be the improvement of permanent income instead of temporary income, and the vigorous policies to reduce income disparity.     

Risk Sharing and Information in Village Economies

Arrangements for achieving efficient risk-sharing vary depending on the information available to agents in the economy. The usual Euler equation restricts efficient allocations in an economy which obeys the permanent income hypothesis, while efficient allocations in an economy with private information and long-term contracts satisfy a symmetric restriction, but not the Euler equation. Full insurance arrangements are unique in that they satisfy both restrictions.
We look at an environment in which it seems likely that long-term contracts play a role in mitigating the effects of private information: three village economies in South India. The evidence that consumption allocations satisfy the private information restriction is quite strong for households in two of the three villages; the evidence for the third village suggests that while consumption for some households satisfies the private information restrictions, other households' consumption obey the permanent income hypothesis.     

Consumer welfare from publicly supplemented private goods: age and income effects on demand for health care

In spite of major advances in the theoretical, positive and normative, literature analysing the welfare implications of public provision of private goods, empirical investigation is often limited to contingent valuation studies, for example, of health care programmes. In this article we argue that when a market for a (subsidised or free of charge) publicly provided good exists, a consumer demand approach can be used to construct a money metric of welfare corresponding to the consumption of public provision. We illustrate this approach in investigating age and income effects on household demand for health care in Cyprus, where free public provision is not universal and those entitled to it often resort to private supplementation. Our findings suggest that the money metric of welfare, which consumers attach to free access to publicly provided health care, varies with age and to a lesser extent with household income.     

How important is the stock market wealth effect on consumption in India?

We examine how shocks emanating from changes in the stock wealth affect the consumption demand in India using a Bayesian VAR framework. The effect of the stock market wealth shock on consumption demand in India is relatively small in magnitude. The estimates suggest that a 10% increase in the real stock wealth raises the consumption demand by 0.3%, which seems to be consistent with some empirical estimates for the emerging market economies given a relatively low share of stock wealth in the household asset portfolio and its asymmetric distribution. The stock market wealth effect being short run in nature does not have a large and persistent effect on consumption demand since consumers may not perceive the changes in the stock wealth to cause a permanent shift in their wealth.     

INDIAN SAVING BEHAVIOR: A RECONCILIATION OF TIME SERIES AND CROSS SECTION EVIDENCE

Serious doubts have been raised as to the validity of using cross-sectional estimates of the average propensity to consume over time. These d⊙ubts are based on empirical evidence for the United States presented by Kuznets and Goldsmith. This paper extends these considerations to developing countries by looking at the evidence for India. Simple statistical techniques, including ordinary least squares regression, Chow tests, and t-tests, are used in the estimation of the consumption functions and the formulation of hypotheses. Both India and the U.S. are seen to exhibit the same characteristic secular constancy in the average propensity to consume. For India the average propensity to consume is about 0.95 and is maintained in the face of no substantial secular increases in per capita income during the period under study (1919–1960).
The same inconsistencies between time series and cross-section evidence on the average propensity to consume are found to exist for India. The permanent income theory suggested only a partial explanation of these inconsistencies and the reconciliation was achieved by a Duesenberry type explanation based on evidence for a shifting cross section consumption function over time. The date was provided by a set of Family Living Surveys for Industrial Workers: 1926, 1933–1935, 1950–1952, 1958–1959.
Finally it was noted that the cross-section consumption function in India had shifted both upwards and downwards over the period under study, in contrast to the strict upward shift for the U.S. In an economy such as India's, where secular growth is by no means assured, it is not always likely that consumers can avoid lowering previously achieved consumption standards in the face of cyclical economic conditions.     

Stock prices and long-run demand for money: evidence from Malaysia

This paper investigates the money demand function for Malaysia in the 1971-1996 period using the multivariate cointegration and error correction model methodology. The results suggest that a stable long-run relationship exist between real M2, the interest rate differential, income and stock prices. Stock prices have a significant negative substitute effect on long-run as well as short-run broad-money demand (M2) and its omission can lead to serious misspecification in the money demand function. The analysis from the vector error correction model (VECM) and the Toda & Yamamoto (1995) causality tests find that money is endogenous and that there is at least a unidirectional relationship between stock prices and real M2. Stock prices Granger cause real M2 indirectly through income between interest rates and stock prices and stock prices and money stock. This paper comes to the conclusion that due to the endogeneity of money, M2 cannot be completely controlled by Malaysia's central bank. Therefore, in formulating future monetary policy, the response of money demand to stock prices should be considered.     

Determinates of the decline in the income-velocity of money in China: a new perspective

The income velocity of money in China has been declining since the country’s reform. By studying the money demand behavior in the agricultural and non-agricultural sectors, we found that the marginal propensity to money demand is much higher in the non-agricultural sector. This implies that as the share of the agricultural sector in national income declines, monetary expansion is expected to meet not only the needs of income growth, but also the rapid structural shifts in the sectoral composition of income. Hence, non-inflationary monetary expansion is possible as development proceeds. This provides a new perspective in understanding the decline in the income-velocity of money in China. __________ Translated from Social Sciences in China (中国社会科学), 2005,(4) (in Chinese)     

On the Variable Money Demand Elasticity: The Case of Taiwan

This study attempts to examine the money-demand function for Taiwan by applying the BCEA model of Savin and White (1978). Major Findings are: (1) the conventional double-log form is inappropriate for Taiwan; (2) the income elasticity of money demand rose from 1.29 in 1969. 2 to 1.74 in 1988. 3, compared to a range of 0.6 to 0.8 estimated for the U.S.; and (3) the interest elasticity of money demand varied from ?0.25 ti ?0.62 during the same period. The author has also found that estimated income and interest elasticities of money demand for the U.S. varied widely during 1970-1987. [310]     

Measuring income elasticity for Swiss money demand: What do the cantons say about financial innovation?

Recent time-series evidence has re-confirmed the forecasting ability of Swiss broad money. The same money demand studies and others, however, find that the income elasticity is greater than one. Such parameter estimates are difficult to reconcile with transactions demand theory. This study re-examines the estimates for income elasticity in money demand based on cross-regional evidence for Switzerland. Particular attention is given to the influence of regional financial sophistication. The cross-cantonal results find that the income elasticity lies between 0.4 and 0.6. This discrepancy between the two empirical methodologies has important consequences for the conduct of Swiss monetary policy.     

Real purchasing power in the neoclassical monetary growth model

In the one sector neoclassical monetary growth model, the balanced growth path under perfect foresight is a saddle point. The paper demonstrates that this instability problem can be resolved by entering real purchasing power into the liquidity preference function as well as into the consumption function. This process allows an additional mechanism based on income effects in money demand by which a change in real balances can influence the growth path. Stability now depends critically on the size of such income effects given wealth effects from money demand. If stability is restored, the nature of the traditional non-neutrality of money must be qualified.