Social and Behavioral Sciences Commons^™

Trends, Random Walks, And Tests Of The Permanent Income Hypothesis, N. Gregory Mankiw, Matthew D. Shapiro

Cowles Foundation Discussion Papers

Recent studies find that consumption is excessively sensitive to income. These studies assume that income is stationary around a deterministic trend. The data, however, do not reject the hypothesis that disposable income is a random walk with drift. If income is indeed a random walk, then the standard testing procedure is greatly biased toward finding excess sensitivity. Moreover, if income is borderline stationary, this procedure is also seriously biased.